1. This is a reference under Section 66(2) of the Indian Income-tax Act, 1922, and the question of law is as follows :
'Whether, on the facts and in the circumstances of the case, the amount of dividends declared in favour of the assessee was rightly taken into consideration by the Income-tax Officer before passing order against the assessee under Section 23A of the Indian Income-tax Act, 1922, as it stood at the material time ?'
2. The assessee is an investment company. The assessee makes lip its accounts as on 31st December each year. In this reference we are concerned with the assessment year 1956-57 and the relevant previous year ends on December 31, 1956.
3. The assessee submitted its return of _ income after making certain adjustments to the profit shown in the profit and loss account. The adjusted income came to Rs. 2,05,840 and was returned for assessment. The assessee was assessed on an income of Rs. 2,36,700, the difference being mainly due to the dividend being grossed up under the law then in force.
4. Included in the income is a sum of Rs. 2,75,640 which was the dividend declared in favour of the assessee on December 28, 1956. The general meeting of the assessee was held on December 29, 1956. The assessee being an investment company should have distributed 100% of the distributable income. The distributable income is the balance left out of the assessed income after deduction of the tax payable thereon and Rs. 1,82,426 was the surplus or distributable income in this case.
5. The Income-tax Officer by his letter dated November 1, 1957, requested the assessee to give reasons why the provisions of Section 23A of the Indian Income-tax Act, 1922, should not be made applicable in this case. The assessee by its letter dated January 15, 1958, inter alia, stated that the profit was computed after taking into account a sum of Rs. 3,21,813 as dividend receivable and this dividend did not reach the hands of the assessee and when such dividend was distributed it was appropriated by the creditors of the assessee.
6. It was contended before the Income-tax Officer by the assessee that the profit made during the year was not substantial and it was not possible for the assessee to include those dividends as they did not reach the hands of the assessee, and, therefore, the assessee should be exempted from the application of Section 23A of the Act, but it was overruled by the Income-tax Officer. The appeal filed by the assessee was dismissed by the Appellate Assistant Commissioner, for, in his opinion, the declaration of dividend in favour of the assessee was enough for the purpose of Section 23A of the Act.
7. The -second appeal filed by the assessee was allowed by the Tribunal, for, in its opinion, the declaration of the said dividend in favour of the assessee was a notional or fictionaj receipt because it was not paid, credited or distributed to the assessee in the assessment, year and, therefore, the said sum of Rs. 2,75,840 should be excluded in calculating the commercial profit of the assessee for the purpose of Section 23A of the Act. In this behalf the Tribunal relied on the decision of the Supreme Court in the case of Commissioner of Income-tax v. Bipinchandra Maganlal & Co. Ltd., : 41ITR290(SC) . and the decision of this court in the case of Indra Singh & Sons Ltd. v. Commissioner of Income-tax : 33ITR341(Cal) .
8. It has been contended before us by Mr. B. L. Pal, the learned counsel for the revenue, that the 'smallness of profit' is not an issue in this reference and, therefore, the decisions cited on behalf of the assessee, before us, have no application. According to Mr. Pal the only question before the Income-tax Officer and the Tribunal was whether in view of the mercantile system of accounting maintained by the assessee the said sum of Rs. 2,75,840 was the commercial profit of the assessee for the relevant assessment year. Hence, it is necessary to refer to the relevant portion of the order of the Income-tax Officer which is as follows :
'Section 23A permits exemption only on two grounds, i.e., loss incurred by the company in earlier years and smallness of profit made in the previous year. It will be seen from the balance-sheet as at 31st December, 1955, being the period relevant to the assessment year 1956-57, that the loss carried forward from the earlier years amounted to Rs. 34,576 only and as the profit made during the year was substantial, it is not possible for the company to raise the plea that it should be exempted from the application of Section 23A. '
9. The order of the Income-tax Officer ex facie shows that the question, of smallness of profit was directly in issue before him and, therefore, we will now look at the relevant portion of the Tribunal's order which is as follows :
'The question presented in this appeal is an interesting one andrelates to the factors which have to be taken into consideration for judgingthe capability of a company to declare dividend. The proposition laid down above would be clear soon, as we say, that the assessee, which is an investment company, has been saddled with an order under Section 23A by reason of its income having been calculated on the basis of certain dividends which had been declared in its favour but had neither been distributed nor been paid to it during the relevant accounting year. There is no dispute with regard to the fact that the dividend of Rs. 2,75,840 declared in the assessee's favour had not been distributed or paid up to the date of passing the assessment order, i, e., up to 25th October, 1957. The total income after deducting certain expenses and other charges ,as per profit and loss account was Rs. 2,05,840 but was assessed at Rs. 2,46,700. This means that if the deemed dividends amounting to Rs. 2,75,840 were not to be considered in computing the said total income for the purposes of Section 23A, there would be no profit left to be distributed by the assessee-company, so that the provisions of Section 23A will not be applicable. The question, therefore, is, as we have stated above, as to whether the fictional or notional receipts could be taken into account for passing orders under Section 23A on the company.'
10. It is true that the Tribunal has said that 'the question......is.........as to whether the fictional or notional receipts could be taken into account in passing orders under Section 23A' of the Act on which reliance was placed by Mr. Pal, but, in our opinion, it must be understood in the context in which it has been said by the Tribunal. The question of smallness of profit was directly an issue before the Income-tax Officer and, in our opinion, the very same issue was also before the Tribunal and the Tribunal went into that question in order to ascertain whether the dividend declared in favour of the assessee could be included in its commercial profit and, therefore, we are not impressed by the contentions of Mr, Pal.
11. The main contention of Mr. Pal is founded upon the mercantile system of accounting followed by the assessee. It has been contended by him that in view of the system of book-keeping of the assessee the dividend declared in favour of the assessee was by itself sufficient to make it ah income of the assessee and, therefore, it should be taken into account in considering the commercial profit of the assessee for the purpose of Section 23A of the Act. In support of this contention he his placed strong reliance on the decision of the Supreme Court in the case of Keshav Mills Ltd. v. Commissioner of Income-tax, : 23ITR230(SC) . In that case the Supreme Court, at pages 239 and 240 of the report, said this :
'The mercantile system of accounting or what is otherwise known as the double entry system is opposed to the cash system of book-keeping under which a record is kept of actual cash receipts and actual cash payments, entries being made only when money is actually collected or disbursed. That system brings into credit what is due, immediately it becomes legally due and before it is actually received and it brings into debit expenditure the amount for which a legal liability has been incurred before it is actually disbursed. The profits or gains of the business which are thus credited are not realised but having been earned are treated as received though in fact there is nothing more than an accrual or arising of the profits at that stage. They are book profits. Receipt being not the sole test of chargeability and profits and gains that have accrued or arisen or are deemed to have accrued or arisen being also liable to be charged for income-tax the assessability of these profits which are thus credited in the books of account arises not because they are received but because they have accrued or arisen... It follows from the above that the mercantile system of accounting treats profits or gains as arising or accruing at the date of the transaction notwithstanding the fact that they are not received or deemed to be received and under that system, book profits are assessed as liable to tax.'
12. Mr. Pal also cited the decision of the Supreme Court in the case of Commissioner of Income-tax v. Gajapathy Naidu, : 53ITR114(SC) on the mercantile system of book-keeping, in support of his contention that the Tribunal erred in excluding the dividends declared in favour of the assessee in calculating its commercial profit.
13. The other submission of Mr. Pal is that those dividends became the income of the assessee the moment they were declared in its favour, for the assessee became legally entitled to recover those sums from the company concerned. In support of this contention he cited the case of Narendra Lal v. Commissioner of Income-tax, : 93ITR534(All) in which it has been held by the Allahabad High Court that the dividend declared in favour of the assessee is an item of asset in his hands under the Wealth-tax Act, 1957, But, the principles, if any, laid down therein, in our opinion, have no application in a case under the Income-tax Act and, therefore, we are not impressed by his contention.
14. The main contention of Mr. Pal is that those dividends declared infavour of the assessee cannot be treated as notional or fictional receipts inview of the mercantile system of book-keeping of the assessee, and,therefore, those sums should be included in calculating the commercialprofits of the assessee. But, in our opinion, the mercantile system of bookkeeping is relevant only for the purpose of assessment of income-tax and ifhas no bearing on the question of actual commercial profits of the assesseefor the purpose of declaring the dividends, for the companies normallydeclare dividends out of their commercial profits. In any event, the mercantile system of accounting, so far as it relates to dividends, cannot override the express provisions of the then Section 16(2) of the Act, which reads as follows :
'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 beed paid, credited or distributed to him...'
15. It has been held by the Supreme Court in the case of J. Dalmia v. Commissioner of Income-tax, : 53ITR83(SC) that 'whether dividend--interim or final--is income taxable in a particular year of assessment must be determined in the light of Section 16(2) of the Indian Income-tax Act' at page 89 of the report. The Supreme Court at pages 89-90 of the report has also said this :
'The legislature had not made dividend income taxable in the year in which it becomes due : by express words of the statute, it is taxable only in the year in which it is paid, credited or distributed or is deemed to be paid, credited or distributed. The legislature has made distinct provisions relating to the year in which different heads of income became taxable... The year in which a particular class of income becomes taxable must, therefore, be determined, in the light of its true character, and subject to the special provision, if any, applicable thereto. The legislature has enacted an express provision making dividend income taxable in the year in which it is paid, credited or distributed or is to be deemed, so paid, credited or distributed. The test applied by Chagla C.J. that because the dividend becomes due to the assessee who has the right to deal with or dispose of the same in any manner he likes, it is taxable in the year in which it is declared, cannot be regarded as correct. The expression 'paid' in Section 16(2) it is true does not contemplate actual receipt of the dividend by the member. In general, dividend may be said to be paid within the meaning of Section 16(2) when the company discharges its liability and makes the amount of dividend unconditionally available to the member entitled thereto. Chagla C.J. has himself in Purshotamdas Thakurdas v. Commissioner of Income-tax,  34 ITR 204 expressed a different view. The learned Chief Justice in delivering the judgment of the court referred to Laxmidas Mulraj Khatau's case,  16 ITR 248 . and observed that the principle of that case applied only to those cases where in fact the dividend was paid to the shareholder and not to cases where a contingent liability was undertaken and no payment was made. He observed :
'One thing is clear from the language used by the legislature that it did not intend to equate 'paid' with 'declared' in every case. Therefore, it is open to us to consider, notwithstanding the Khatau Mills' case, whether, on the facts of this case, it could be said that dividend has been paid, which although it may have been declared may never be payable and in fact has not been paid.'If the mere declaration of dividend in general meeting of the company is not to be regarded as payment within the meaning of Section 16(2), much less can it be said that a resolution declaring interim dividend--which is capable of being rescinded by directors--operates as payment before the company has actually parted with the amount of dividend or discharged its obligation by some other act.'
16. It has also been held by the Supreme Court in the case of Ramesh R. Saraiya v. Commissioner of Income-tax, : 55ITR699(SC) that a dividend cannot be said to be 'credited' within the meaning of Section 16(2) of the Act unless it is made unconditionally available to the assessee. And in delivering the majority judgment of the Supreme Court in the case of Punjab Distilling Industries Ltd. v. Commissioner of Income-tax : 57ITR1(SC) Subba Rao J. (as he then was) at page 9 of the report, said that the expression 'distribution' connotes something actual and not notional '.
17. Hence, it is well-established by the above decisions of the Supreme Court that a mere declaration of dividend in favour of the assessee is not enough even for the purpose of Section 16(2) of the Act and, therefore, much less can it be said those dividends became the commercial profits of the assessee by their mere, declaration in favour of the assessee. Further, in the case of Commissioner of Income-tax v. Bipin Chandra Maganlal & Co. Ltd., at page 296 of the report, the Supreme Court says this :
'A company normally distributes dividends out of its business profits and not out of its assessable income. There is no definable relation between the assessable income and the profits of a business concern in a commercial sense. Computation of income for purposes of assessment of income-tax is based on a variety of artificial rules and takes into account several fictional receipts, deductions and allowances. In considering whether a larger distribution of dividends would be unreasonable, the source from which the dividend is to be distributed and not the assessable income has to be taken into account. The legislature has not provided in Section 23A that, in considering whether an order directing that the undistributed profits shall be deemed to be distributed, the smallness of the assessable income shall be taken into account. The test whether it would be unreasonable to distribute a larger dividend has to be adjudged in the light of the profit of the year in question. Even though the assessable income of a company may be large, the commercial profits may be so small that compelling distribution of the difference between the balance of the assessable income reduced by the taxes payable and the amount distributed as dividend would require the company to fall back either upon its reserves or upon its capital which in law it cannot do. For instance, in the case of companies receiving income from property, even though tax is levied under Section 9 of the Act on the bona fide annual value of the property, the actual receipts may be considerably less than the annual value and if the test of reasonableness is the extent of the assessable income and not the commercial profit, there may frequently arise cases in which companies may have to sell off their income-producing assets. The legislature has deliberately used the expression ' smallness of profit' and not 'smallness of , assessable income ' and there is nothing in the context in which the expression 'smallness of profit' occurs which justifies equation of the expression 'profit' with 'assessable income'. Smallness of the profit in Section 23A has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional.'
18. In the case of Commissioner of Income-tax v. Gangadhar Banerjee & Co. (Private) Ltd. : 57ITR176(SC) the Supreme Court on Section 23A of the Act, at pages 181-182 of the report, said as follows :
'To act under this section the Income-tax Officer has to be satisfied thai the dividends distributed by the company during the prescribed period are less than the statutory percentage, i.e., 60 per cent. of the assessable income of the company of the previous year less the amount of income-tax and super-tax payable by the company in respect thereof. Unless there is a deficiency in the statutory percentage, the Income-tax Officer has no jurisdiction to take further action thereunder. If that condition is complied with, he shall make an order declaring that the undistributed portion of the assessable income less the said taxes shall be deemed to have been distributed as dividends amongst the shareholders. But before doing so, a duty is cast on him to satisfy himself that, having regard to the losses incurred by the company in earlier years or * the smallness of the profit made', the payment of a dividend or a larger dividend than that declared would be reasonable. The argument mainly centred on this part of the section. Would the satisfaction of the Income-tax Officer depend only on the two. circumstances, namely, losses and smallness of profit Can he take into consideration, other relevant circumstances What does the expression 'profit' mean Does it mean only the assessable income or does it mean commercial or accounting profits If the scope of the section is properly appreciated the answer to the said question would be apparent. The Income-tax Officer, acting under this section, is not assessing any income to tax ; that will be assessed in the hands of the shareholder. He only does what the directors should have done. He puts himself in the place of the directors. Though the object of the section is to prevent evasion of tax, the provision must be worked not from the standpoint of the tax collector but from that of a businessman. The yardstick is that of a prudent businessman. The reasonableness or the unreasonableness of the amount distributed as dividends is 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 others. He must take an overall picture of the financial position of the business. It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income-tax Officer, It depends upon the facts of each case. The only guidance is his capacity to put himself in the position of a prudent businessman or the director of a company and his sympathetic and objective approach to the difficult problem that arises in each case. We find it difficult to accept the argument that the Income-tax Officer cannot take into consideration any circumstances other than losses and smallness of profits. This argument ignores the expression ' having regard to ' that precedes the said words.'
19. And again at page 183 of the report the Supreme Court says this :
'The expression 'smallness of profit' came under the judicial scrutiny of this court in Commissioner of Income-tax v. Bipin Chandra Maganlal & Co. Ltd. Therein, Shah J., speaking for the court, observed thus :
'Srnallness of the profit in Section 23A has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional. This view appears to have been taken by the High Courts in India without any dissentient opinion.' The learned judge laid down the following test : ' Whether it would be unreasonable to distribute a larger dividend has to be adjudged in the light of the profits of the year iu question ?' If the assessable income was the test and if the commercial profits are small, the learned judge pointed out, the company would have to fall back either upon its reserves or upon its capital which in law it could not do. This decision is binding on us and no further citation in this regard is called for. These two concepts, 'accounting profits' and ' assessable profits ', are distinct. In arriving at the assessable profits the Income-tax Officer may disallow many expenses actually incurred by the assessee ; and in computing his income, he may include many items on notional basis. But the commercial or accounting profits are the actual profits earned, by an assessee calculated on commercial principles. Therefore, the words ' smallness of profit ' in the section refer to actual accounting profits in comparison with the assessable profits of the year.'
In the case of J.P. Srivastava & Sons (Bhopal) Private Ltd. v. Commissioner of Income-tax, : 57ITR624(SC) the Supreme Court, at page 628 of the report, said :
'......that the Income-tax Officer, in proceedings under Section 23A, must determine commercial profits. In proceedings under Section 23 he is not concerned with this. There he is concerned with assessable income or profits. Therefore, it is difficult to appreciate why a finding in the assessment order that a particular income is assessable income or profits necessarily means that that assessable income must form part of the accounting profits.'
The law, in our opinion, is well-settled on the question involved before us. 'Accounting profits' and assessable profits are two differentconcepts under the Income-tax Act. 'The commercial or accounting profits are the actual profits earned by an assessee calculated on commer cial principles'. While acting under Section 23A of the Act, the Income-tax Officer must not act as a tax collector, but should act as a prudentdirector of the company. In the absence of any special circumstances noprudent director will ever take into account the money which has nevercome into the hands of the company for the purpose of distribution. It isthe duty of the Income-tax Officer to take an overall picture of the financialposition of the company at the date of distribution. He ' must determinethe commercial profits ' of the company which must be the actual availableprofits at the date of declaration of dividends and such available commercial profits must be calculated by him from a broad commercial point ofview.
Actual commercial profits may be far less than the book entries under the mercantile system of accounting and, therefore, in our opinion, the Tribunal has rightly held that for the purpose of passing an order under Section 23A of the Act the distributable profits in the instant case ' have to be calculated keeping in view the profits of the previous year as can be calculated by a trader in calculating his profits '. It has been held by this court in the case of Indra Singh & Sons Ltd. v. Commissioner of Income-tax, at pages 346-347 of the report, that while acting under Section 23A of the Act the Income-tax Officer ' must pay regard only to the money that was actually at the disposal of the company and not money of which it might be deemed to be possessed '.
Hence we are not impressed by the contentions of Mr. Pal noted earlier, and we return our answer in the negative and in favour of the assessee. In the facts and circumstances of this case, there will be no order as to costs.
R.N. Pyne, J.