MITTER J. - The question referred to this court under section 66(1) of the Income-tax Act is :
'Whether, on the facts and in the circumstances of the case, the Income-tax Officer was justified in applying the provisions of section 23A(1) of the Income-tax Act to the assessee-company for the assessment year 1952-53 ?'
The facts are as follows : For the relevant assessment year 1952-53, the corresponding previous year of the assessee was the one ending on March 30, 1952. The company showed in its return a total income of Rs. 1,49,935. At a general meeting of the shareholders held on May 27, 1953, dividends totaling Rs. 62,500 were declared. At first the company was assessed at an income of Rs. 2,79,635. The Income-tax Officer passed an order under section 23A(1) declaring that a further sum of Rs. 96,668 out of the undistributed profits shall be deemed to have been declared as dividends and proportionate share thereof attributable to each shareholder shall be included in his total income. On appeal the Appellate Assistant Commissioner held that the two sums of Rs. 52,577 and Rs. 60,939 included by the Income-tax Officer in the assessment were notional and unrealistic income and should, therefore, be left out in considering the applicability of section 23A. Eliminating these two amounts the Appellate Assistant Commissioner found that the assessable income was Rs. 1,66,119, the income-tax and super-tax liability thereon was Rs. 1,21,467 and hence, the dividend declared was more than 60 per cent. of the distributable income and section 23A was not applicable. The Tribunal did not accept the decision of the Appellate Assistant Commissioner but still found in favour of the Assessee, reasoning as follows : According to the Tribunal the assessees accounting profit or commercial profit for the year of account was Rs. 1,06,461. No reserve had been set apart for the tax liability on this income which was approximately Rs. 46,000. Deducting this sum from the commercial profit the balance of the divisible profit was Rs. 60,461 and the assessee having declared dividends in excess of the amount was not within the mischief of section 23A(1).
It was admitted by counsel appearing before us that the above figures are not quite correct in view of the revision of the assessment. The revised figures are :
(1) Assessable income
(2) Tax liability thereon
(3) Commercial profits
(4) Tax paid in advance
(5) Tax liability on the commercial profits
The material portion of section 23A(1), as it stood at the relevant time, provided as follows :
'Where the Income-tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company up to the end of the sixth month after its accounts for that previous year are laid before the company in general meeting are less than 60 per cent. of the assessable income of the company of that previous year, as reduced by the amount of income-tax and super-tax payable by the company in respect thereof he shall, unless he is satisfied that having regard to losses incurred by the company in earlier years or to the smallness of the profit made, the payment of a dividend or a larger dividend than that declared would be unreasonable, make with the previous approval of the Inspecting Assistant Commissioner an order in writing that the undistributed portion of the assessable income of the company of that previous year as computed for income-tax purpose and reduced by the amount of income-tax and super-tax payable by the company in respect thereof shall be deemed to have been distributed as dividends amongst the shareholders as at the date of the general meeting aforesaid, and thereupon the proportionate share thereof of each shareholder shall be included in the total income of such shareholder for the purpose of assessing his total income'.
The sub-section is not to apply to any company in which the public are substantially interested. There is no dispute here that the company is not one of that type and hence sub-section (1) would be applicable if the conditions mentioned in it are found to occur. The section has been interpreted in various decisions and may be split up in two portions : the first portion lays down the test to be applied in finding out whether the distribution is such to call for investigation. For this purpose three figures have to be taken into account, viz. :
(1) the assessable income;
(2) the income tax and super tax payable in respect thereof; and
(3) the total dividend actually distributed. If the third figures is less that 60 per cent. of the difference between the first two, the sub section may be attracted if the conditions mentioned in the second portion are present. According to the second portion, even if the distribution is less that 60 per cent. of the assessable income minus the tax payable the Income-tax Officer must still consider whether it was reasonable for the company to distribute more than it did having regard to the losses incurred in earlier years or to the smallness of the profit made. The expression 'smallness of the profit made' brings in an element of uncertainty. There have, however, been number of decisions on this point which should guide us in interpreting the expression correctly. It was pointed out as early as in 1949 in Kasturchand Ltd. v. Commissioner of Income tax by Chagla C.J. that 'in determining whether an order should be made or not under that section, the Income tax Officer has got to consider not the assessable income of the company but the actual profits made by it... what the Income tax Officer has got to consider is the actual accounting profits made by the company and not the profits assessed to income tax or super tax by the Income tax Officer.' By 'accounting profit' his Lordship meant the commercial profit. His Lordship further opined that 'the smallness of the profit has reference merely to the possibility of a dividend or a larger dividend being declared being unreasonable. The smallness of the profit has no bearing on other factors, e.g., the extent of the paid up capital or the fact that the company has been functioning for a very short period or any other factor...' In Bipinchandra Maganlal and Co. Ltd. v. Commissioner of Income-tax, which came before the same Bench of the Bombay High Court the question which arose was whether a sum of money (the excess amount received by sale of machinery over its written down value) which was to be taken into account in computing the assessable income under the proviso to section 10(2) (vii) of the Act was to be included in the commercial profits of the company for the purposes of section 23A. This was negatived on the ground that it was a notional income. Incidentally the Bench was also called upon to examine the contention as to whether reserves accumulated by the assessee in the past could be taken into account in computing the smallness of profit for the purpose of declaring a dividend. It was said 'section 23A does not require the Income tax Officer to consider the reserves built up by the company in the past... the principle is this that when you are considering the profits of a company for the purposes of section 23A and when you have to take into consideration the actual or the commercial profits, you cannot take into consideration profits made in the past years which have been allocated to a depreciation reserve or to any other reserve.'
This decision was upheld in appeal by the Supreme Court : see Commissioner of Income tax v. Bipinchandra Maganlal & Co. It was there said that : 'A company normally distributes dividends out of its business profits and not out of its assessable income... 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 dividend 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 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. .... 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.'
In New Mahaluxmi Silk Mills Ltd. v. Commissioner of Income tax, the facts were as follows : The assessee distributed Rs. 12,300 as dividend to the shareholders. The Income tax Officer assessed the assessable income at Rs. 1,37,693 and made an order under section 23A. The Tribunal assessed the Commercial profits of the assessee at Rs. 56,800 and computed on that amount a tax liability of Rs. 19,325. It was held that Rs. 37,475 was the net commercial profit for the year and the distribution being less than 60% of that figure, the order under section 23A was properly passed. The Bombay High Court was of the view that in making a deduction of Rs. 19,325 only for tax liability the Tribunal fell into error and observed : 'The income tax payable by an assessee does not bear any definite relation to his commercial profits. Even if the assessee has made payments which he is not entitled to deduct in ascertaining the assessable income, the commercial profits are to that extent depleted. It would, therefore, in our judgment, be an error to reduce merely the amount of tax computed on the commercial profits to ascertain the profits made... It was, therefore, for the Income tax Officer to ascertain, having regard to the commercial profits, the anticipated amount of tax which would have to be deducted to find out the net commercial profits, in the light of all the circumstances then present to its mind, and thereafter to relate the same to the amount of dividend declared.' The Bench further held that the expression 'profit made' occurring in section 23A (1) was the figure arrived at by deducting the amount of tax payable from the gross commercial profit.' The same view was taken by the Bombay High Court in Bombay Cycle Stores Co. (P) Ltd. v. Commissioner of Income-tax.
In Indra Singh & Sons Ltd. v. Commissioner of Income-tax it was held by Chakravartti C.J. (page 346) that the word profit in the expression 'smallness of the profit made' would only refer to accountable profits and not the net assessable income composed of accounting profits and partly of notional income, coming in either as disallowed items of expenditure or as income computed on some artificial basis. According to the learned Chief Justice 'obviously, notional income cannot be distributed and, therefore, in judging the reasonableness or otherwise of a companys action in distributing dividend at the rate at which it actually made the distribution or in making no distribution at all, one 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'. His Lordship further held that in order to find out whether the dividend declared was sufficient, the Income tax Officer 'must pay regard to the profit which was available to the company for distribution as dividend or, to put in other words, the size of the distributable fund which the company had in its hands. It is undoubtedly true that a company can distribute dividend only out of its profits, although capital profits also may, in certain cases, be distributable as dividend. But, broadly speaking, dividends are declared out of what we may call the revenue profits. But if dividend is distributable only out of profits, it is equally the law that all profits derived from whatever source shall contribute to the fund out of which the dividend may be declared or to put in other and simpler words the profits which are distributable as dividend are profits derived from all sources.'
From all these decisions it is clear that in considering the sufficiency of the dividend declared when the Income-tax Officer finds that 60% of the assessable income less the taxes have not been distributed he must proceed to consider whether in view of the losses of earlier years or the smallness of the profit made a larger dividend was distributable. For this purpose he must take into account only the distributable profits and deduct therefrom the tax liability of the company on the assessable income and then consider whether the distribution was reasonable in the circumstances of the case.
In my view, in considering the smallness of the profit made on must consider the profit available for distribution as compared to the commercial profits as also the capital structure of the company. Smallness is a relative term. A profit of Rs. 1,00,000 when the capital of the company is Rs. 10,00,000 would not be considered small but it would certainly be described as such if the capital was one crore of rupees. Again if the commercial profits are Rs. 2,00,000 but the assessable income is found to be Rs. 5,00,000 by the addition of notional or fictional income the tax liability may be nearly as high as the commercial profits and in that case a prudent company would hardly think of distributing any dividend. But I find myself unable to hold that in considering the smallness of the profit made for the purpose of distribution one must also take into account other factors like the reserves of the company or its future development projects. The legislature wanted the Income-tax Officer to take into account the losses of the earlier years and the smallness of the profit made. Whatever be the reason, the legislature did not think it proper that the Income tax Officer should embark upon a consideration of other liabilities or assets of the company.
In this case, we find that the accounting profits are Rs. 1,06,461. The tax liability was Rs. 93,719 out of which Rs. 25,128 had already been paid. Therefore, there was a further tax liability of approximately Rs. 68,000. Deducting this sum from the accounting profits we get a balance of Rs. 38,000. The actual distribution being much in excess of the figure the case is not one where it would have been reasonable to distribute a larger sum. The learned advocate for the revenue contended that in considering whether a larger distribution was reasonable the Income-tax Officer may take into consideration the reserves which the company had accumulated in earlier years and he referred to the case of Commissioner of Income-tax v. Williamson Diamonds Ltd. There the question which arose under section 21(1) of the Income-tax Consolidation Ordinance, 1950, of Tanganyika which was much to the same effect as section 23A of our Act. The Judicial Committee had to consider whether the word 'losses' in the Tanganyika Ordinance should be interpreted to include capital losses. The Board expressed itself thus : 'The form of words used no doubt lends itself to the suggestion that regard should be paid only to the two matters mentioned, but it appears to their Lordships that it is impossible to arrive at a conclusion as to reasonableness by considering the two matters mentioned isolated from other relevant factors. Moreover, the statute does not say having regard only to losses previously incurred by the company and to the smallness of the profits made. No answer, which can be said to be in any measure adequate, can be given to the question of unreasonableness by considering these two matters alone. Their Lordships are of the opinion that the statute by the words used, while making sure that losses and smallness of profit are never lost sight of, requires all matters relevant to the question of unreasonableness to be considered. Capital losses, if established, would be one of them.'
On the strength of the above it was urged that we should also look into the reserves to find out the true position of the company and if we find that the company has built up substantial reserves we ought to take the view that section 23A should be applied even if the distribution is not unreasonable considering only the accounting profits and the tax liability. I find myself unable to accept this argument. If the true position of the company including its reserves and other factors unspecified in the section are to be taken into consideration the section should have been differently worded. In my view, the reasonableness of the distribution is to be measured in terms of the distributable profits and the tax liability of the relevant year or the losses carried forward from earlier years. The decision of the Judicial Committee is not an interpretation of the Indian Act although the language used in the Tanganyika Ordinance is very similar to that of the Indian statute. I humbly venture to take a different view.
In my opinion, the distribution in this case was not unreasonable taking the relevant matters into consideration and the question posed must be answered in the negative in favour of the assessee who will have the costs of this reference.
Masud J. - I agree.