K.L. ROY J. - This reference arises in the following circumstances : The assessee, Messrs. Bangodaya Cotton Mills Limited, is a company and there is no dispute that it was a company in which the public were not substantially interested within the meaning of Explanation 1 to section 23A(9) of the Indian Income-tax Act, 1922, for the assessment years 1955-56 and 1956-57, the corresponding previous years of the company being the financial years ending on the 31st March, 1955, and the 31st March, 1956, respectively. There is also no dispute that for those two years, under the provisions of section 23A as it then stood, the company had to distribute 60 per cent. of its distributable surplus as determined under that section. The Income-tax Officer found that the companys assessed profits were Rs. 4,14,669 and Rs. 5,34,366, respectively, and, after deduction of income-tax and super-tax payable thereon, the distributable surplus amounted to Rs. 2,23,491 and Rs. 3,02,824, respectively, for the aforesaid two years. As the company had not declared any dividend within the statutory period of 12 months from the end of the respective previous years, the Income-tax Officer required the assessee to show cause why the provisions of section 23A should not be applied to it in respect of these two years. The company had declared dividends of two identical sums of Rs. 49,266 for the aforesaid two assessment years on 5th of September, 1956, and 31st of July, 1957, respectively, that is, after the lapse of the statutory period of 12 months from the end of each of the relevant previous years. The company submitted to the Income-tax Officer that it had imported some spinning machinery during the financial year 1952-53, at heavy cost, thereby incurring debts to the extent of over Rs. 11,00,000. The company had to borrow a large sum of money from Lloyds Bank Limited, to whom a sum of Rs. 1,97,354 was paid as interest, but was disallowed in the companys assessment. The company had to borrow a further large sum from the Life Insurance Corporation of India also at high interest and on condition of paying commission. It was, therefore, submitted that owing to the smallness of profits it was not reasonable for the company to have declared a larger dividend than that already declared. The Income-tax Officer was unable to accept this contention as, in his opinion, what was to be taken into account in considering the application of section 23A was the commercial profits earned by the company. In this case the companys book profit for the assessment year 1955-56 was Rs. 81,945 and the amount brought forward from the profit and loss balance of the earlier year was Rs. 1,29,185, thereby giving a book profit for this year of Rs. 2,11,130. Similarly, the assessees profits as per its profit and loss account for the assessment year 1956-57 were Rs. 3,17,033. He held further that the debts incurred by the assessee for a capital expenditure could not be taken into consideration in considering the smallness of profits under section 23A. The Income-tax Officer was of opinion that if the company was in financial difficulties, it should have approached the Commissioner under section 23A(3), seeking his sanction for either not distributing any dividends or for distributing a smaller amount of dividend. Accordingly, the Income-tax Officer charged super-tax on the company on the entire distributable surplus for these two years. On the assessees appeals against the aforesaid orders under section 23A to the Appellate Assistant Commissioner, the same contentions were raised. In addition to the facts found by the Income-tax Officer, the Appellate Assistant Commissioner observed that in the year 1955-56, the assessee had following reserves, namely, (a) Reserve for plant and machinery - Rs. 5,00,000; (b) Investment reserve - Rs. 38,390; (c) Contingent Reserve - Rs. 60,000; (d) Reserve for bad debt - Rs. 32,047; and these reserves had, for the subsequent year, increased to Rs. 6,50,000, Rs. 46,375, Rs. 60,000 and Rs. 33,918 respectively. As there was not any loss incurred by the assessee in earlier years and as the book profits disclosed for the years under consideration could not be considered to be small, the Appellate Assistant Commissioner upheld the orders of the Income-tax Officer and dismissed the assessees appeals.
Dissatisfied with the order of the Appellate Assistant Commissioner, the assessee appealed to the Income-tax Appellate Tribunal. Before the Tribunal, the assessee submitted two statements purporting to show the surplus available to the assessee after deducting its liabilities from its assessed profits for these two years. The liabilities deducted were the assessees income-tax liabilities for the past years as well as the present year and its liabilities incurred in connection with the import of the spinning machinery. On the basis of these liabilities, the assessee showed a distributable surplus of Rs. 4,485 for the first year and a nil surplus for the second. The same contentions were raised by the assessee before the Tribunal, namely, that though it had suffered no loss in the past years and had sufficient profits in its profit and loss account for declaring a dividend, yet taking into consideration its heavy liabilities in respect of the import of spinning machinery, it should be considered that it was not reasonable for the assessee to have declared a dividend larger than that declared for these two years. The Tribunal accepted the assessees contention and, after considering an unreported decision of this court in Gangadhar Banerjee & Co. Ltd. v. Commissioner of Income-tax, made the following observations :
'In the present case, if we were not to look to the imperative commitments and the necessary outgoings which were facing the assessee, the simple position would be that according to the book results for the specific period of each of the two years in question, the assessee had the adequate profits in its books, and, therefore, it must declare the statutory percentage of its profits as dividends. But if the imperative commitments, in the shape of paying interest on the loans, the commission for the Life Insurance Corporation Loan, and income-tax liabilities for past years besides several other expenses which it was bound to meet were also alongside to be worded at, the position would be that by declaring dividend to the extent of the statutory percentage of 60 per cent., it would have been definitely unable to meet the other commitments. May be that it has not actually met such commitments during the particular periods, but all the same if it had paid out 60 percent. of its profits as dividend, it would not have been able to meet the other commitments. The question, therefore, arises, which action could be considered more reasonable from the commercial mans point of a view-whether it would pay the dividend and be a lost person, or to restrict the payment of dividend to nil or to nominal amount and to have a chance of survival by being able to meet the other imperative demands on it ?'
And, again : 'The assessee, in our opinion, has naturally to look to the various necessary outgoings to judge the situation in its reality and not only to look to its business profits. In doing so, the assessee had necessarily not only to deduct the admissible and revenue expenses but also such commitments and outgoings, even though they may be of capital and inadmissible nature, to find out as to the amount, which it has been actually left with, to be distributed as dividend.
In the instant case the assessee has placed before us its total commitments and expenses which it must have to incur. The commitments are so heavy that if the company be forced to pay it at once, all its capital and reserves would be hardly sufficient to meet the enforcement. Although the surplus disclosed by deducting a part of such commitments and expenses comes to a paltry sum of Rs. 4,485 in the assessment year 1955-56, and to nil in the assessment year 1956-57, the assessee had itself declared dividend to the tune of Rs. 49,256. Be that as it may, on a consideration of the entire facts and circumstances of the case and the necessary commitments which the assessee has to fulfil, we hold that the companys profits were small within the meaning of the term smallness of profit under section 23A and any further declaration of dividend would be unreasonable.'
The Tribunal accordingly allowed the assessees appeals.
At the instance of the Commissioner, the Tribunal has referred the following question of law to this court :
'Whether, on the facts and in the circumstances of the case, the profits of the assessee-company for the assessment year 1955-56 and 1956-57 were small within the meaning of the expression smallness of profits in section 23A of the Indian Income-tax Act, 1922, and that any further declaration of dividend than that declared by the assessee would be unreasonable ?'
Since the decision of the Tribunal, the Supreme Court had to interpret the words 'losses incurred by the company in earlier years or the smallness of profit made', occurring in section 23A before its amendment, in 1953. As the section, both before and after the aforesaid amendment, requires the Income-tax Officer to be satisfied that having regard to the losses incurred by the company in earlier years or to the smallness of the profit made in the previous year, the payment of a dividend or a larger dividend than that declared would be unreasonable before applying the provisions of that section; the amendment made in 1953 is not material so far as the question with which we are concerned and the observation of the Supreme Court would be equally applicable to the case of the assessee. Both the learned counsel for the revenue and the assessee, very properly, confined their arguments to the principles laid down by the Supreme Court in the that case.
It would, therefore, be convenient to set out the tests laid down by the Supreme Court for considering whether the dividends declared by assessee-company in these two years were reasonable on consideration of the smallness of profits of the company during the corresponding previous years. In Commissioner of Income-tax v. Gangadhar Banerjee & Co. (Private) Ltd. the Supreme Court observed as follow at page 181 :
'This section was introduced to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher taxation. To act under this section the Income-tax Officer has to be satisfied that 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.... He (the Income-tax Officer) 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.'
Mr. Sen, learned counsel for the Commissioner, argued that, in view of the aforesaid observations of the Supreme Court, he could not object to the Tribunal taking into consideration the capital expenditure and non-commitant outgoings in considering the surplus available for distribution. But he argued while taking such liabilities into account, the Tribunal erred in not taking the corresponding reserves, particularly the capital reserves also into consideration for determining whether it was reasonable for the assessee-company to have declared a larger dividend than that declared in these two years. It was submitted that the Appellate Assistant Commissioner had found the assessees reserves in the first year, as already pointed out, to be substantial and these reserves had been augmented in the second year showing that the reserves were not utilised for the purpose of reducing the assessees capital liabilities. It was, therefore, submitted that the Tribunal was in error in holding that it would be unreasonable for the assessee to have made any further declaration of dividend.
Mr. Banerjee, learned counsel for the assessee, submitted that the capital reserves shown in the assessees balance-sheet were not reserves at all, as the assessees share capital together with the capital reserves fell far short of the value of the fixed assets. We are unable to accept this submission in the absence of any findings to that effect by the authorities below. Mr. Banerjee further argued that the Tribunal had accepted the assessees computation of commercial profits for these two years. We are unable to agree. The Tribunal accepted the determination of the book profits of the assessee for these two years by the Income-tax Officer and the Appellate Assistant Commissioner. The figures furnished by the assessee to the Tribunal were not actually the computation of the commercial profits of the assessee-company but a computation of the surplus that would be left to the company if its liabilities on capital account as well its liabilities for income-tax of previous year were deducted from its assessed profits for each of these two years. Mr. Banerjee pointed out that it was not correct to say that the Tribunal had not considered the reserves of the company. As a matter of fact, the Tribunal had observed at page 21 of the paper book as follows :
'In the instant case the assessee has placed before us its total commitments and expenses which it must have to incur. The commitments are so heavy that if the company be forced to pay it at once, all its capital and reserves would be hardly sufficient to meet enforcement.'
Mr. Banerjee further pointed out that the Tribunal had found that the company would have gone into liquidation if the onerous loan was not taken from the Life Insurance Corporation and that the fixed assets had to be hypothecated. It was submitted that no company would take loans if its capital and reserves were sufficient to meet its liabilities. Mr. Banerjee further pointed out that a similar argument was raised before the Supreme Court in Gangadhar Banerjees case by the Attorney-General at page 180 of the report to the following effect :
'..... and, as the balance-sheet of the company for the relevant year showed a sum of Rs. 1,05,950 as capital reserve brought forward, a sum of Rs. 5,73,161 as taxation reserve, and a sum of Rs. 56,000 as estimated tax, the Income-tax Officer rightly held that the financial condition of the company was sufficiently sound to warrant an order under section 23A of the Act.'
It was pointed out that the Supreme Court had not accepted that contention in that case as in holding that the amount available for distribution was a small sum of Rs. 4,000, the Supreme Court had not taken into consideration the reserves of the assessee-company.
What we have to consider in this case in whether the decision of the Tribunal, that though the assessee had sufficient book profits in those two years to have declared a larger dividend and had not suffered any losses in the immediately preceding years, in view of its commitments and liabilities incurred, which being on the capital account would not be allowable as a deduction in the assessees income-tax assessments, it would not be reasonable for a prudent businessman to have declared a larger dividend than that already declared by this company, was correct. The Tribunal has observed that the assessee could have declared a dividend up to the statutory percentage and not pay its liabilities or it could have paid its liabilities and not declared a divident. It could not have done both. The Tribunal has considered it more reasonable, from the commercial mans point of view, for the assessee not to have declared a larger dividend but to have employed its profits for meeting its other present liabilities. Such a view could not be said to be unreasonable. As the Supreme Court observed in the aforesaid case, the reasonableness or the unreasonableness of the amount distributed as dividend was to be adjudged 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. The Income-tax Officer and the Appellate Assistant Commissioner were certainly in error in considering only the past losses and present profits. They ignored the availability of any surplus money and the reasonable requirements of the future. The Tribunal had taken into consideration all these factors and had come to the conclusion that a prudent businessman would have preferred to meet its liabilities rather than pay further dividends. the conclusion arrived at by the Tribunal, in view of the aforesaid decision of the Supreme Court, cannot be said to be unjustified or irrational.
In the view we take, the question referred to this court must be answered in the affirmative and in favour of the assessee. The assessee is entitled to the costs of this reference.
BANERJEE J. - I agree.
Question answered in the affirmative.