SANKAR PROSAD MITRA J. - This is a reference under section 66(1) of the Indian Income-tax Act, 1922. The assessee has been held to be a company in which the public were not substantially interested within the meaning of section 23A of the Act. The assessment year is 1950-51 and the corresponding accounting year ended on March 31, 1950. The point in dispute was whether in view of the loss incurred by the company in the earlier year or the smallness of the profit made during the accounting year, the payment of a dividend would be unreasonable.
The profit disclosed in the accounts of the assessee in the year ending on March 31, 1950, was Rs. 11,190. A loss was disclosed in the accounting year ending on the 31st March, 1948, Rs. 15,470. But the profit and loss account as at the 31st March, 1948, disclosed the net surplus of Rs. 25,731 and thus the net surplus in the profit and loss account as at the 31st March, 1949, was Rs. 10,261. On the 31st March, 1950, according to the balance-sheet, there was also a reserve for Rs. 3,05,000, capital reserve for Rs. 50,067 and a taxation reserve for Rs. 42,052.
The Income-tax Officer applied the provisions of section 23A as no dividend was declared at the annual general meeting when the balance-sheet of the accounting year was considered. In appeal before the Appellate Assistant Commissioner, the case was decided in favour of the assessee. The Appellate Assistant Commissioner held that considering the earlier loss and the current years profits and considering the subscribed capital of the company which was Rs. 5,50,000 divided into 11,000 shares of Rs. 50 each, the profit was too small to warrant application of the provisions of section 23A. He also held that in deciding the matter, the income-tax payable on the profits should also be considered as a relevant factor.
The Appellate Tribunal reversed the order of the Appellate Assistant Commissioner. It held that the Appellate Assistant Commissioner was wrong in considering the subscribed and paid-up capital of the company in relation to the profits available for distribution and the question of setting aside any portion of the profit for income-tax liability was not relevant for the purpose of finding whether the profit was small. It, therefore, held that, in the absence of any other reason before it, the Appellate Commissioners order must be set aside and the Income-tax Officers order must be restored.
The following question of law arises in this referenc :
'Whether, on the facts and in the circumstances of the case, an order under section 23A(1) of the Income-tax Act was sustainable in la ?'
The relevant portions of section 23A(1) as they stood during the accounting year in question were as follow :
'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% 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 purposes 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 principles emerging out of this section relevant for our purposes in this reference have been judicially considered on a number of occasions. These principles ar :
(1) The object underlying section 23A is to prevent avoidance of super-tax by the shareholders of a company in which the public are not substantially interested. The rates of super-tax applicable to companies are much lower than the highest rates applicable to other assessees. The income-tax paid by the company is deemed to have been paid on behalf of the shareholders, but the shareholders have to pay super-tax again in respect of the dividends even if the dividends are paid out of profits which have borne super-tax in the hands of the company. An individual might avoid the high incidence of super-tax by transferring to a private limited company, in return for shares, the source of his income, and by securing that, instead of any dividend being declared the profits made by the company should be allowed to accumulate in the hands of the company and should be ultimately distributed in a capital form by creating bonus shares which are not assessable as income in the hands of the shareholders. This section aims at foiling an attempt to avoid super-tax by such means. But the section would apply even if in a given case there is no intention to evade super-ta : vide Kanga & Palkhivala on Income-tax, 4th edition, volume 1, page 582, and the decision of the Supreme Court in Sardar Baldev Singh v. Commissioner of Income-tax.
(2) The test of reasonableness indicated by the section has therefore to be applied keeping the above object in view.
(3) The 'smallness of profit' in section 23A has to be adjudged in the light of commercial principles and not in the light of assessable income or total profits, actual or fictional. In other words, it is the business profit or commercial profit that has to be taken into accoun : see the Supreme Courts judgment in Commissioner of Income-tax v. Bipin Chandra Maganlal & Co.
(4) The 'smallness of profit' is a relative or comparative concept. The smallness may be with reference to numerous tests or standards, such as, for instance, the assessees capital structure, his projects of development, actual payment of taxes to be provided for and anticipated against and many other business and commercial consideration : vide the judgment of P. B. Mukharji J. (sitting with Niyogi J.) in I.T.R. No. 85 of 1956 (Gangadhar Banerji & Co. v. Commissioner of Income-tax at page 9).
(5) There is no abstract conception of 'reasonableness' and each case must depend on its own fact : Thomas Fattorini (Lancashire) Ltd. v. Commissioner of Inland Revenue.
(6) All considerations which ordinary commercial men take into account are relevant to determine whether it is unreasonable to declare a dividen : vide the decision of the Privy Council in Commissioner of Income-tax v. Williamson Diamonds Limited and Income-tax Reference No. 85 of 1956, ibid. at pages 9 and 10.
(7) The crucial test appears to be whether the assessee could have produced sums out of which it could declare a dividend without jeopardising the interests of the company. The tax authorities must show that it was commercially possible for the company to distribute as dividend a reasonable part of its actual incom : vide Thomas Fattorinis case.
These are the principles which are to be applied to the facts of this case. Mr. E. R. Meyar, learned counsel for the assessee, has contended before us that 'smallness of profit' has to be considered in the background of the subscribed and the paid-up capital of the company and the profit available for distribution to each shareholder. That is also, submits Mr. Meyer, the judgment of P. B. Mukharji J. in I. T. Reference No. 85 of 1956. We are unable to express any opinion on this point urged by Mr. Meyer in the absence of evidence or materials as to how many shares were held by each shareholder of this private limited company. The percentage compared to the paid-up capital may be small but the shareholding may have been distributed in such a manner that each shareholder would get a substantial sum. We are, therefore, not inclined to go into this question in this reference. Mr. Meyers next contention is that the test whether it would be unreasonable to distribute a dividend or a larger dividend has to be adjudged in the light of the profit of the year in question. With this contention we agree and that is also the judgment of the Supreme Court in Bipin Chandra Maganlals case. Mr. Meyer then says that this company earned a profit of only Rs. 11,000 in the year in question, but it had suffered a loss of more than Rs. 15,000 in a previous year. And against the background of this loss it was not commercially possible, indeed, it was wholly unreasonable for this company to declare a dividend. This argument does not however appeal to us when we look at the facts of this case. In the statement of the case we find that the profit disclosed in the accounts of the assessee in the year ending upon March 31, 1950, which was the year in question was Rs. 11,190. No doubt there was a loss disclosed in the accounting year ending upon the 31st March, 1948 of Rs. 15,470, but the profit and loss account as on the 31st March, 1948, disclosed a net surplus of Rs. 25,731 and thus the net surplus in the profit and loss account as at the 31st March, 1949, was Rs. 10,261. These facts, in our judgment, demolish the contentions of Mr. Meyer based on previous loss.
The first requirement of section 23A is that the company must be one in which the public are not substantially interested. This requirement has been satisfied in the instant case. The second requirement is that the company has not distributed sixty per cent. of its assessable income as reduced by the amount of income-tax and super-tax payable by the company in respect thereof. This requirement has also been satisfied in the instant case. In fact, this company has declared no dividend at all. It is true that the Income-tax Officer before he makes a penal order under section 23A has to be satisfied that having regard to losses incurred by the company in earlier years or to the 'smallness of profit' made, the payment of a dividend would not be unreasonable. Now, what are the facts her I have already said that the previous loss on the fact of this case is not material consideration. I have also said that 'smallness of profit' cannot be judged in this case properly and adequately with reference to the capital structure in the absence of all relevant materials. From the facts relied on by learned counsel for the Commissioner, we find that the assessed income of the company was about Rs. 22,453 and the tax payable was about Rs. 11,927 leaving a balance of about Rs. 10,526. Sixty per cent. of this balance comes to about Rs. 6,300. There was no necessity for this company to fall back upon its capital or reserves for declaring this sum of Rs. 6,300 or a reasonable portion thereof as dividend. A scrutiny of the balance-sheet shows also that all other contingencies had been provided for. There was a reserve for Rs. 3,05,000, a capital reserve for Rs. 50,067 and a taxation reserve for Rs. 42,052. Every possible precaution which a business man should take for the future has, it appears, been taken by this company. In the premises we may not fully agree with the reasonings of the Tribunal, but we have to support the conclusion it has reached. We are clearly of opinion that the order under section 23A in the instant case was not unjustifiable.
Our answer to the question framed is, therefore, in the affirmative. The applicant will pay to the respondent the costs of this reference.
SEN J. - I agree.
Question answered in the affirmative.