Sabyasachi Mukhakji, J.
1. In this reference we are concerned with two relevant assessment years being assessment year 1961-62 for which reference has been made under Section 66(1) of the Indian Income-tax Act, 1922, and the assessment year 1962-63 for which reference has been made under Section 256(1) of the Income-tax Act, 1961. In this combined reference two questions have been referred to this court, namely :
'(1) Whether, on the facts and in the circumstances of the case, the profit of the assessee-company for the assessment years 1961-62 and 1962-63 was small within the meaning of the expression ' smallness of profits' in Section 23A of the Indian Income-tax Act, 1922, or Section 104 of the Income-tax Act, 1961, as the case may be, and that any further declaration of dividend than that declared by the assessee would be unreasonable?
(2) Whether, on the facts and in the circumstances of the case, any larger dividend than that declared by the company could reasonably be distributed within the meaning of Section 23A of the Indian Income-tax Act, 1922, or Section 104 of the Income-tax Act, 1961, as the case may be, and the application of Section 23A of the Indian Income-tax Act, 1922, and Section 104 of the Income-tax Act, 1961, was in accordance with law?'
2. As mentioned hereinbefore we are concerned with two assessment years being assessment year 1961-62 for which the relevant previous year ended on 30th September, 1960, and the assessment year 1962-63 for which the relevant previous year ended on 30th September, 1961. There is no dispute that this was a case of a company in which provision of Section 23A of the Indian Income-tax Act, 1922, and/or provisions of Section 104 of the Income-tax Act, 1961, would apply. There is no dispute also as to the distributable income for these two years. The distributable income for the assessment year 1961-62 was Rs. 1,47,351 and for the assessment year 1962-63 was Rs. 1,32,795. For the assessment year 1961-62 the statutory percentage at 50% would have been Rs. 73,676 and for the assessment year 1962-63, Rs. 66,398. The profits actually distributed for the first year was Rs. 30,000 and for the second year Rs. 30,005, respectively. The Income-tax Officer proposed to take action under Section 23A and Section 104 of the relevant Acts because the dividend distributed was, according to him, inadequate. The assessee was asked to show cause. The assessee contended that no levy of additional super-tax under the provisions of the said section should be made having regard, to, (1) the need for setting apart some amounts as reserve, and (2) providing for the payment of taxes for which no provision had been made. The Income-tax Officer did not accept this explanation and passed orders under Section 23A for the assessment year 1961-62 and under Section 104 for the assessment year 1962-63. There was an appeal before the Appellate Assistant Commissioner who upheld the orders of the Income-tax Officer and dismissed the appeal. There was a further appeal to the Tribunal. The Tribunal came to the conclusion that the amount set apart for reserve and provision made for taxes were not what a prudent businessman would have necessarily made in the circumstances of the case and as such dismissed the appeal. In the aforesaid circumstances the aforesaid two questions have been referred to this court.
3. In order to appreciate the controversy in this case, it would be necessary to refer to the position of the account. It was claimed by the assessee after making provisions, for transferring to the reserve fund and for payment of taxes as was done under the 'profit and loss appropriation account', the amounts available out of the profits were Rs. 28,910 for the assessment year 1961-62 and Rs. 29,564 for the assessment year 1962-63 and dividend declared for each of these two years being about Rs. 30,000 was in excess of the amount which, according to the assessee, was possible by drawing on the balance brought forward from the preceding years. In order to appreciate the position it would be relevant to refer to certain facts.
4. Net profit for the year 1961-62 was Rs. 1,13,910 and for the assessment year 1962-63 was Rs. 1, 19,564. Out of this a sum of Rs. 40,000 for the assessment year 1961-62 was transferred to the reserve fund and a sum of Rs. 45,000 was transferred really to the income-tax account in writing off the income-tax liability debt of the company which had been previously debited to the account of the shareholders and thereafter which was transferred to the account of the company. A sum of Rs. 45,000 for the assessment year 1961-62 and a sum of Rs. 50,000 for the assessment year 1962-63 were accordingly transferred to a reserve fund and sums of Rs. 45,000 and Rs. 40,000 were transferred to the income-tax writing off account. In these two years by transferring to the reserve fund, i.e., for the assessment years 1961-62 and 1962-63, taking into consideration the transfer to the reserve fund and income-tax account, sums of Rs. 85,000 and Rs. 90,000 were transferred respectively leaving aside balances of Rs. 28,910 and Rs. 29,564 for the two years respectively. There were certain amounts brought forward from the previous years which for the year 1961-62 amounted to Rs. 4,462 and Rs. 3,372 for the year 1962-63. Adding these, the money available in hand was Rs. 33,372 and Rs. 32,936 for these two years respectively. Out of these, dividends were declared for about Rs. 30,000 and the balance of about Rs. 3,372 for the year 1961-62 was carried forward; for the year 1962-63 dividends were declared for Rs. 30,005 leaving a balance of Rs. 2,936 which was carried forward. In order further to appreciate the position it would be necessary to refer to the order of the Tribunal where certain facts are to be found. It appears that the company was in existence for some time. The figures of profit made by the company prior to 1954 were not available. It appears that the company was established some time in or about 1929. The figures are available only from the accounting year ending 30th September, 1933. It the order of the Tribunal at page 25 would also establish that between 1933 and 1953 the company made a profit of about Rs. 12,680. Between 30th September, 1954, and 30th September, 1959, the company made a profit of about Rs. 2,89,482. These figures indicate that in 1954 the company made a profit of about Rs. 39,216. In 1955 the company made some profit but in 1956 the company's profit was Rs. 99,920. 1957 and 1958 were not so much profitable for the company. In 1959 again the company made a profit of Rs. 49,144. In these two yeaRs. i.e., for the years with which we are concerned ending on 30th September, 1960, and 30th September, 1961, the company made a profit of Rs. 1,13,910 and Rs. 1, 19,564, respectively. There was an article being Article 15 of the articles of association of the company which provides as follows :
'The directors shall set apart at least 2/64ths of the net profits of the company every year to a reserve account until that reserve account has accumulated to one lakh of rupees.'
5. It appears according to the Tribunal, that total profits as hereinbefore mentioned for the year ending 30th September, 1959, came to Rs. 3,02,163 and 2/64ths thereof was Rs. 9,442. Up to that year a sum of Rs 10,000 was credited only to reserve account. But, according to the Tribunal, 2/64ths of the profits made for the two relevant years would amount to Rs. 3,560 and Rs. 3,736 respectively. Therefore, the Tribunal was of the opinion that the provision made for Rs. 40,000 and Rs. 50,000 respectively for these two years by carrying over to the reserve fund was grossly excessive and it was not what a prudent businessman must necessarily have done in the circumstances of the case. We have to consider whether in coming to this conclusion the Tribunal bore in mind the correct principles. The principles which the Tribunals and the courts should follow have been clearly enunciated by the Supreme Court in the case of Commissioner of Income-tax v. Gangadhar Banerjee & Co. Pvt. Ltd. It was stated that the Income-tax Officer, in considering whether the payment of a dividend or a larger dividend than that declared by the company would be unreasonable within the meaning of Section 23A of the Indian Income-tax Act, 1922, did not assess any income to tax. He only does what the directors should have done putting himself in their place. Though the object of the section, according to the Supreme Court, was to prevent evasion of taxes, the provision must be worked not from the standpoint of the tax collector but from that of a businessman. Reasonableness or unreasonableness of the amount distributed as dividend should be judged by business considerations, such as the previous losses, the present profits, the availability of surplus money and the reasonable requirements of the future and similar other position of the business. He should put himself in the position of a prudent businessman or the director of a company and deal with the problem with sympathetic and objective approach.
6. The Supreme Court further reiterated that Section 23 A was in the nature of a penal provision and, therefore, the revenue had to strictly comply with the conditions laid down therein. The burden lay upon the revenue to prove that the conditions laid down thereunder were satisfied before the order could be made. Bearing the above principles in mind we have to consider whether the provision made for these two years. namely, assessment years 1961-62 and 1962-63, for the sums of Rs. 40,000 and Rs. 50,000 respectively for building up the reserve was grossly excessive or whether from a prudent businessman's point of view this could be considered as unreasonable. The Tribunal proceeded mainly in judging this question on the basis of the aforesaid Article 15 referred to hereinbefore. The Tribunal was of the opinion that inasmuch as the article only enjoined that only 2/64ths net profit was obligatory to be transferred to a reserve fund, the sums proposed to be transferred to the reserve funds for building up the reserve were from that point of view, in view of the provisions made, grossly excessive. It has to be borne in mind that the articles or any provision of the articles of this nature do not conclude the matter. The directors or the shareholders cannot by providing an article of this nature artificially create a reserve fund. It has first to be examined whether the article in the context of the business needs and the needs of the company was itself a reasonable one and, secondly, it has to be borne in mind that the article in question in the instant case does not stipulate that only 2/64ths net profit of every year should be transferred. What the article stipulates is that at least 2/64ths should be set apart. That does not prevent in appropriate circumstances, for instance, in a year where the company has made substantial profits in the background of the reserve already built up and in the background of the needs of the company, to set apart any larger proportion than 2/64ths of the net profit. In this context, we have to bear in mind that the company over the years have not been, according to the findings of the Tribunal, able to build up more than Rs. 10,000 in the reserve fund. It has, however, to be borne in mind that in other years the company did not make as large a profit as it did in the years in question. In these two years the profits made by the company in proportion to the profits made in other years were fairly high. Furthermore, it has to be borne in mind that the dividends already distributed amounted to about 25 per cent. of the amount invested in the capital of the company. Having regard, therefore, to the amount of the reserve accumulated or set apart by the company over the years and having regard to the fact that in these two years the company had made substantial profits and having also regard to the fact that in other years profits were not as large as in these two years and in the background of the fact that a fairly large return had been distributed to the shareholders on the investment of shares, we are of the opinion that it cannot be said from a business or commercial point of view that the reserves, that is, transfer to the reserve fund, of Rs. 40,000 and Rs. 50,000, respectively, in these two years could be termed as excessive. After all, it has to be borne in mind that these considerations must be taken from a business point of view and not from the point of view of what was commercially necessary but what was commercially desirable. The Tribunal, therefore, in our opinion approached the question from a wrong angle in considering that these reserves were not necessary in the circumstances. It is not so much to question whether these reserves were necessary to be made. What is required to be examined is whether these reserves were prudent to be made from a business point of view and in the background of the facts as set out before we do not think, if the board of directors have thought it fit to set apart these two sums of the reserve, it could be termed as either excessive or unreasonable.
7. The next aspect of the matter is about the provision made for payment of tax for which no provision had been made. It appears that in the accounts of the year ended 30th September, 1953, the demand for tax for a sum of Rs. 70,562 was debited pro rata to the account of the shareholders with corresponding credit for the amount in income-tax account where income-tax had been debited. During the following year a sum of Rs. 1,04,677 was also similarly debited on the 31st March, 1954, to the account of the shareholders. Such debits were subsequently objected to by the shareholders and, accordingly, on the 1st of October, 1954, the first day of the accounting year ended on the 30th September, 1955, a reversing entry was passed crediting the sum of Rs. 1,75,239 to the account of the shareholders and debiting the same to the income-tax, account. In other words, the liability which was passed on as the liability of the shareholders was taken as liability of the company and that had to be liquidated. This happened prior to 1954. It was because of the wrong entry provision had to be made for liquidating this as and when situation arose and funds were available. The Tribunal pointed out that since the year 1954 the company had been making provision for payment of taxes and these provisions, according to the Tribunal, were not shown to be inadequate. Provision was made for the year ending 30th September, 1954, for Rs. 60,000; similar provision was made for the year ending 30th September, 1955, for Rs. 75,000 and similar provision was made for the year ending 30th September, 1956, for Rs. 1,00,000. But these provisions were not available for meeting the liability or writing off the debt of the company which arose prior to 1953 when the company had wrongly debited the shareholders. From year to year the company had written off certain amounts. Dealing with this contention the Tribunal stated that the details were not furnished before the Tribunal and the starting point was the year ending 30th September, 1956, when the assessee considered it necessary to write off only Rs. 75,239 of the income-tax account. A sum of Rs. 1,00,000 was, as shown in the statement referred to in paragraph 11, considered to represent unadjusted payment of income-tax, excess profits tax and business profits tax. In paragraph 17 at page 26 the Tribunal expressed the opinion that the company did have reserve or provision for taxation. It is true that the company did have reserve or provision for taxation. But the question is not whether provision was made for taxation each year from the year ending 30th September, 1954, and that provision might not have been inadequate. There was no provision at least that the earlier years' debit would be made out of the provision made subsequently--since 30th September, 1954, there was a debit. A sum of Rs. 75,239 was written off in the year the company made some profits. But the Tribunal observed that the assessee for its own reasons which are apparent from the account did not write off the balance sum of Rs. 1,00,000. The company did not have sufficient funds or available surplus to write off this sum from the profit and loss appropriation account. The question on this aspect of the matter, therefore, also is, whether in writing off this amount in these two years when the company had made substantial profits the company was spending a large amount or whether it did not have income-tax debt or whether the conduct of the directors of the company was unreasonable. It has not been established from the provision for taxation this debt or this liability for the years prior to 30th September, 1954, could be met. Having regard to the state of affairs we are of the opinion that it cannot be said that this conduct of the assessee could also be termed either as unreasonable or excessive.
8. Before we conclude this matter we must observe that counsel for therevenue drew our attention to the decision of the Supreme Court in the caseof Commissioner of Income-tax v. Kamal Singh Rampuria, : 75ITR157(SC) . We cannot goto the validity of the facts but it is not a question in the instant case whether the facts are correct or not but the question is whether, on the facts,the inferences drawn by the Income-tax Officer and the Tribunal werecorrect from the commercial and reasonable point of view on the basis ofthe principles indicated by the Supreme Court in the case of Commissionerof Income-tax v. Gangadhar Banerjee & Co. (Pvt.) Ltd. : 57ITR176(SC) Having consideredthis aspect from this point of view, we are of the opinion that in this context it could not be said that the larger dividend should have been declaredand not having done so the directors of the company acted unreasonably.
9. In the aforesaid view of the matter question No. 1 is answered in the affirmative and in favour of the assessee and question No. 2 is in the negative and also in favour of the, assessee. Each party will pay and bear its own costs.
10. I agree.