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PETITIONER: COMMISSIONER OF INCOME-TAX, BOMBAY CITY IBOMBAY

       Vs.

RESPONDENT: JUBILEE MILLS LTD.  BOMBAY

DATE OF JUDGMENT: 05/12/1967

BENCH: RAMASWAMI, V. BENCH: RAMASWAMI, V. SHAH, J.C. BHARGAVA, VISHISHTHA

CITATION:  1968 AIR  883            1968 SCR  (2) 539

ACT: Income Tax Act, 1922, s. 23-A-Company reconstructing capital to write off accumulated losses and reducing capital-Whether losses  prior  to reconstruction  relevant  for  determining reasonableness   of  company  not  declaring   dividend   in subsequent year as prescribed by s. 23-A-S. 66(5) -Procedure to  be followed by Tribunal after High Court deciding  ques- tion against the view taken by Tribunal.

HEADNOTE: The  respondent  company had suffered large  losses  in  the years  prior to 1930 and in that year it  reconstructed  its capital by adjusting a debit balance of Rs. 12,75,000 in the profit  and  loss account against the paid  up  capital  and reducing  the face value of its shares.  For the  accounting year relative to the assessment year 1948-49, the respondent Company  declared  a dividend amounting only to  Rs.  24,750 although in terms of s. 23-A of the Income-tax Act, 1922, it was  prima facie liable to declare a much  larger  dividend. The  Income-tax  Officer  therefore held  that  the  company should  be  deemed  to  have  declared  a  dividend  of  Rs. 3,98,798.   The respondent’s appeals against this  order  to the  Appellate  Assistant  Commissioner  and  the  Appellate Tribunal   were  dismissed.   The  Tribunal   rejected   the respondent’s  contention  that in view of  the  past  losses suffered by the company, it was not reasonable to expect  it to  declare  a  larger dividend.  It  held  that  after  the reconstruction  of its capital the company emerged in a  new cloak of reduced capital and for the purposes of determining the applicability of s. 23-A the reconstructed capital alone had to be taken into account and not the original capital, a great  portion  of  which bad been  wiped  out  by  debiting losses.   The High Court, upon a reference, held  that  the, loss  of Rs. 12,75,000 incurred by the company prior to  its reconstruction in 1930 could be taken into consideration for the purposes of the applicability of s. 23-A. On appeal to this Court, HELD:(i)  The view taken by the Appellate Tribunal  was erroneous in law and the High Court had rightly answered the question referred to it in favour of the respondent-company. There  is nothing in the language or context of is.  23-A(1)

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of  the Act to suggest that the expression "losses  incurred in  the earlier years" should be construed go as to  exclude losses incurred prior to the reconstruction ,and to  include only unadjusted or carried forward losses still  outstanding in  the  books  of the company.  The  section  requires  the Income-tax  Officer to take into consideration  "the  losses incurred  by  the  company  in the  earlier  years"  or  the "smallness  of profits made".  It is  well-established  that the profits which are to be considered under s. 23-A(1)  are the  commercial  or  the  accounting  profits  and  not  the assessable income or the assessable profits of the  company, because  it  is  the commercial  or  the  actual  accounting profits which are to form the source from which the dividend is  to  be  distributed and not  the  assessable  income  or assessable  profits  which  may  have  no  relation  to  the commercial  or  accounting  profits and which  are  not  the actual source out of which the dividend could be paid.  [544 G-H: 545 A-C] 540 C.I.T.  West  Bengal v. Gangadhar Banerjee, 57  I.T.R.  176, referred to. If a company which has got over its losses for some years by adjusting them against its capital and reducing its  capital makes  a profit in the subsequent year it may  theoretically be in a position to distribute the whole of its profits  for that  year but it cannot be said to have acted  unreasonably if  it  chose  not to do so and retained a  portion  of  the profits  for  the purPose of building up a  capital  reserve which  in course of time would enable the company to  regain its original strength of capital.  It may be that even after taking  into consideration losses prior to a  reconstruction it  is possible to come to the conclusion that  the  company was  not justified-in not declaring a larger  dividend  than that actually declared.  But in the present case the  Tribunal had misdirected itself in law in holding  that losses  incurred prior to the reconstruction are  irrelevant for the purpose of application of s.   23-A in subsequent years. [545 E-G; 546 A-B] (ii)The  High  Court having rightly answered  the  question referred  to  it in favour of the assessee  meant  that  the Tribunal  must now, in conformity with the judgment  of  the High  Court, act under a. 66(5) of the Act, that is to  say, dispose of the case after re-hearing the respondent  company and  the Commissioner in the light of the evidence and  ding to law. [547 B-D] Income-tax  Appellate  Tribunal,  Bombay  and  Ors.  v.  SC. Cambatta & Co.  Ltd. 29 I.T.R. 118 and Esthuri Aswathiah  v. The C.I.T. Mysore, C.A. No. 631/1966 dated 18-4-67, referred to.

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 525 of 1967. Appeal  from the judgment and order dated May 3/4,  1963  of the  Bombay  High Court in Income-tax Reference  No.  40  of 1957. B.   Sen and R. N. Sachthey, for the appellant. S.   P.  Mehta, S., E. Dastoor and I. N.  Shroff,  for  the, respondent. The Judgment of the Court was delivered by Ramaswami,  J. This appeal is brought, by certificate,  from the judgment of the Bombay High Court dated May 3/4, 1963 in Income Tax Reference No. 40 of 1957.

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The respondent-company is a limited liability company with a paid  up  capital of Rs. 15,25,000/- as on  June  30,  1947. Prior  to  1930 the respondent-company  had  suffered  large losses and in 1930 a debit balance of Rs. 12,75,000/- in the profit  and  loss  account  of  the  respondent-company  was adjusted by reducing the paid up capital.  The face value of the  Ordinary shares was reduced from Rs. 100/- to Rs.  10/- each  and  of Preference shares from Rs. 100/- to  Rs.  25/- each after obtaining the sanction of the Bombay High  Court. For  the  assessment year 1948-49, for  which  the  relevant previous  year  was  the  year  ended  June  30,  1947,  the respondent-company  was  assessed to a total income  of  Rs. 7,47,639/-.  On that amount tax was calculated at 541 Rs. 3,27,091/- and the balance available for distribution by way of dividends for the purpose of s. 23A of the Income-tax Act,  1922  (hereinafter  referred to  as  the  ’Act’)  was, therefore, Rs. 4,20,548/-.  Section 23A of the Act  requires a  company  in  which  the  public  are  not   substantially interested  to  declare in the absence  of  certain  special circumstances a dividend which would not be less than 60% of the  said  balance.  The respondent  company  therefore  was prima  facie  liable to declare a dividend of at  least  Rs. 2,52,358/- in order to escape the penal consequences of non- compliance  with  the provisions of the said  section.   The actual dividend which was declared by the respondent-company was  only  Rs. 24,750/-.  The Income-tax  Officer  with  the previous approval of the Inspecting Assistant  Commissioner, therefore,  applied the provisions of s. 23A of the  Act  to the  respondent-company and held that the company should  be deemed  to have declared a dividend of Rs. 3,95,798/-.   The respondent-company  appealed  to  the  Appellate   Assistant Commissioner of Income-tax against the order of the  Income- tax  Officer but the appeal was dismissed.  The  respondent- company  thereafter filed a second appeal to the  Income-tax Appellate  Tribunal.  By its order dated September  7,  1955 the Appellate Tribunal confirmed the order made under s. 23A of  the  Act  and dismissed the appeal.   It  was  contended before  the Appellate Tribunal on behalf of the  respondent- company  that in view of the past losses suffered by it  the nondeclaration  of  a  dividend larger  than  that  actually declared  was not unreasonable.  It was argued that in  view of the past losses of Rs. 12,75,000/- it was not  reasonable to   expect  the  respondentcompany  to  declare  a   larger dividend.   The  argument  of  the  respondent-company   was rejected by the Appellate Tribunal.  It stated as follows in the course of its order: "It  is  true  that company incurred large  losses  in  past years.   But it reconstructed its capital in 1930.  In  that year,  the debit balance in the profit and loss account  had been  set off against the paid-up capital  thereby  reducing the   paid-up   capital   of   the   company.    After   the reconstruction,  the  company  emerged in  a  new  cloak  of reduced  capital.   For  the,  purpose  of  determining  the applicability of provision of Section 23A, in our view,  the reconstructed capital alone has to be taken into account and not the original capital, a great portion of which had  been wiped  out  by  debiting losses.   Those  prior  losses  had already  been wiped out by writing off against the  paid  up capital.  They cannot now be taken for consideration." At  the  instance of the  respondent-company  the  Appellate Tribunal  referred  the following questions of law  for  the opinion of the Bombay High Court: 542 "1.  Whether  on the facts and in the circumstances  of  the

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case, the Income-tax Officer was competent to pass an  order u/s.  23(1) of the Act after having allowed a rebate of  one anna  per rupee in the assessment under the proviso  (a)  to paragraph  (B)  of  Part 1 of the  Second  Schedule  of  the Finance Act, 1948 ? 2.If  the answer to question No. 1 is in the  affirmative whether  on the facts and in the circumstances of the  case, the  assessee company is a company in which the  public  are substantially interested for the purposes of sec. 23A of the Act ? and 3.Whether  the  loss of Rs. 12,75,000/- incurred  by  the company prior to its reconstruction in 1930, could be  taken into consideration for purposes of the applicability of sec. 23A (1) of the Act?" By its judgment dated March 13, 1958 the High Court answered the  first  question in the affirmative,  holding  that  the Income-tax  Officer was competent to pass an order under  s. 23A(1)  and he was not precluded from doing so by reason  of his having granted rebate to the respondent-company.  On the second  question also the High Court gave its answer in  the affirmative,  holding  that  the  respondent-company  was  a company in which the public was substantially interested for the purpose of s. 23A of the Act.  In view of the answer  to the  second  question the provisions of S. 23A  of  the  Act would  not be applicable to the respondent-company  and  the third question became academic, and the High Court  declined to  answer  it.   The Commissioner of  Income-Tax  took  the matter  in  appeal to this Court which reversed  the  answer which  the High Court had given to question No. 2  and  held that the respondentcompany was a company in which the public were not substantially interested for the purpose of S.  23A of  the Act.  In view of the decision of this Court  on  the second  question it became necessary for the High  Court  to consider  the  third  question  and  this  Court   therefore remanded  the reference to the High Court for  consideration of  the  third question.  After the remand  the  High  Court heard the reference again and by its judgment dated May 3/4, 1963  answered the third question in the affirmative and  in favour  of the respondent-company.  It was held by the  High Court  that  the  losses  prior  to  reconstruction  of  the respondent-company  in 1930 which were set off  against  the paid-up  capital could be taken into consideration  for  the purpose of application of S. 23A of the Act. Section  23A of the Act before its amendment in 1955, in  so far as it is material, states as follows: "23A.   Power  to  assess  individual  members  of   certain companies- (1)where the income-tax officer is satisfied that in respect of  any previous year the profits and gains  distributed  as dividends  by  any company upto the end of the  sixth  month after  its accounts for that previous year are  laid  before the company in general meeting are less than sixty per  cent of  the  assessable income of the company of  that  previous year, as reduced by the amount of the 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

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dividend  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 543 Provided  further that this sub-section shall not  apply  to any company in which the public are substantially interested or to a subsidiary company of such a company if the whole of the share capital of such subsidiary company is held by  the parent company or by the nominees thereof. Explanation.-For the purpose of this sub-section, a  company shall  be  deemed to be a company in which  the  public  are substantially interested if shares of the company (not being shares entitled to a fixed rate of dividend, whether with or without a further right to participate in profits)  carrying not less than twenty-five per cent of the voting power  have been    allotted    unconditionally    to,    or    acquired unconditionally by, and are at the end of the previous  year beneficially held by the public (not including a company  to which  the provisions of this subsection apply), and if  any such  shares have in the course of such previous  year  been the subject 544 of dealings in any stock exchange in the taxable territories or  are in fact freely transferable by the holders to  other members of the public." when  it is found that the company in which the  public  are not substantially interested has declared a dividend of less than 60% of the assessable income of the company as  reduced by  the  amount of income-tax and super-tax payable  by  the company  in  respect  thereof for any  previous  year.   The section,   however,   has   provided  that   even   if   the applicability  of  the section is attracted,  the  Incometax Officer has to consider whether, having regard to the losses incurred by the company in earlier years or having regard to the   smallness   of  its  profits,  it  would   have   been unreasonable  for the company to declare a  dividend  larger than  which  it had actually declared., The  object  of  the section is to collect super-tax from the shareholders  which would  be payable if the company had distributed its  income by  way of dividends and to discourage avoidance of  tax  by failing to distribute its income. On behalf of the appellant Mr. B. Sen put forward the  argu- ment  that as a result of the reconstruction of the  capital in  1930  a  new  chapter had opened  in  the  life  of  the respondent-company and losses which it had suffered prior to the reconstruction of its capital were irrelevant and should not  be considered for the purpose of s. 23A of the  Act  so far as subsequent years are concerned.  It was said that for determining the application of S. 23A of the Act it was  the reconstructed  capital  alone and not the  original  capital that  had  to be taken into account.  It was  pointed  on,,, that   though  the  reduction  of  the  capital   had   been necessitated  by lcsses suffered, the reconstruction of  the capital  had resulted in wiping out the losses and  starting the  company  afresh with reduced  capital  as  its  paid-up share  capital.   The argument was stressed that  where  the company  adjusts  losses  against the  paid-up  capital  and reconstructs  its  capital, the financial  position  of  the company and its dividend distributing capacity in subsequent years  have to be judged only by the result of  its  trading after  reconstruction  and  not with  reference  to  earlier losses  which  have  disappeared  by  adjustment.   In   our opinion,  there is no warrant, for the argument put  forward

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on  behalf  of  the  appellant.  There  is  nothing  in  the language or context of s. 23A(1) of the Act to suggest  that the expression "losses incurred in the earlier years" should be  construed so as to exclude losses incurred prior to  the reconstruction  and  to include only unadjusted  or  carried forward  losses  still  outstanding  in  the  books  of  the company.,  In  our opinion, the losses which have  been  ad- justed  in  the  books  of  the  company  at  the  time   of reconstruction  do not cease to be "losses incurred  by  the company  in  the  earlier years" within the  meaning  of  S. 23A(1).  The section requires                             545 the  Income-tax  Officer  to take  into  consideration  "the losses incurred by the company in the earlier years" or "the smallness of profits made." It is Well-established that  the profits  which are to be considered under s. 23A(j) are  the commercial or the accounting profits and not the  assessable income or the assessable profits, of the company, because it is the commercial or the actual accounting profits which are to  form  the  source  from which  the  dividend  is  to  be distributed  and  not the assessable  income  or  assessable profits  which  may have no relation to  the  commercial  or accounting  profits and which are not the actual source  out of which the dividend could be paid.-See C.I.T., West Bengal v.  Gangadhar Banerjee(1).  On a similar line  of  reasoning the  consideration of losses in the earlier years should  be made  in the setting and context of the inquiry whether  the company could be regarded as acting reasonably in  declaring a  smaller  dividend.  It is true that as a  result  of  the losses  having  been adjusted against the  paid-up,  capital they  no  longer  remain as  unadjusted  losses  or  carried forward losses but it does not mean that they cease to  have any impact on the financial position of the company in  sub- sequent years.  Even if the company resorts to the method of wiping out the losses by adjusting them against its capital, the  procedure  results in crippling its  finances  and  the company  in  future  years may  reasonably  take  steps  for improving  its crippled financial position.  If therefore  a company  which  has got over its losses for  some  years  by adjusting them against its capital and reducing its  capital makes  a profit in the subsequent year it may  theoretically be in a position to distribute the whole of its profits  for that  year but it cannot be said to have acted  unreasonably if  it  chose  not to do so and retained a  portion  of  the profits  for  the purpose of building up a  capital  reserve which  in course of time would enable the company to  regain its original strength of capital which had been crippled  by the adjustment of losses at the time of reconstruction.   We are  therefore unable to accept the argument put forward  on behalf of the appellant on this aspect of the case.  In  our opinion, the Appellate Tribunal misdirected itself in law in holding that the losses incurred prior to the reconstruction of the respondent-company are irrelevant for the purpose  of application of s. 23A of the Act in subsequent years.  As we have  already  said,  the  losses  incurred  prior  to   the reconstruction  having been adjusted are no longer shown  in the  books of the company.  It does not, however, mean  that the  losses  cease  to have their effect  on  the  financial position  of  the company in subsequent  years.   It  cannot therefore be said that the losses prior to reconstruction do not fall within the ambit of the expression "losses incurred by  the  company in earlier years" for the  purpose  of  the application of s. 23A of the Act.  Such losses are  relevant to  be considered even though they may not be  surviving  in the books of

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(1) 57 I.T.R. 176. L2S up CI/68-4 546 the company as unadjusted or carried forward losses.  It may be that even after taking such losses into consideration  it is  possible to come to the conclusion that the company  was not  justified in not declaring a larger dividend than  that actually  declared.  But what the Tribunal has done in  this case is that it has refused to take such losses into account at  all  because  it  has  taken  the  view  that  by  their adjustment against the capital the losses do not survive for consideration  for the purpose of the application of s.  23A of  the  Act.  The view taken by the Appellate  Tribunal  is erroneous  in law and we are of opinion that the High  Court has  rightly answered the third question in the  affirmative and in favour of the respondent-company. But it is necessary to give certain effective directions, so that a mere order of dismissal of this appeal may not result in  injustice.   Section  66(5)  of  the  Act  requires  the Tribunal  on  receiving a COPY of the judgment of  the  High Court to pass such orders as are necessary to dispose of the case  conformably  to such judgment.   The  section  clearly imposes  an obligation upon the Tribunal to dispose  of  the appeal in the light of and conformably with the judgment  of the  High Court.  If the High Court agrees with the view  of the  Tribunal,  the appeal may be disposed of  by  a  formal order.  But if the High Court disagrees with the Tribunal on a  question of law, the Appellate Tribunal must  modify  its order  in the light of the order of the High Court.  If  for example  the  High Court has held that the judgment  of  the Tribunal is vitiated, because it is based on no evidence  or because the judgment proceeds upon a misconstruction of  the statute,  the  Appellate Tribunal would be under a  duty  to dispose of the case conformably with the opinion of the High Court  and  on  the merits of the dispute,  and  rehear  the appeal after giving notice to the parties and redetermine it in  accordance with law.  In Income-tax Appellate  Tribunal, Bombay  and  Ors. v.  S. C. Cambatta and Co.   Ltd.,(1)  the Bombay High Court explained the procedure to be followed  as under : when a reference, is made to the High Court either under  s. 66(1)  or  section  66(2)  the  decision  of  the  Appellate Tribunal cannot be looked upon as final; in other words, the appeal is not finally disposed of.  It is only when the High Court   decides   the,   case,   exercises   its advisory jurisdiction,  and  gives  directions  to  the  Tribunal  on questions  of law, and the Tribunal reconsiders  the  matter and  decides  it,  that  the  appeal  is  finally  ’disposed of.......... it is clear that what the Appellate Tribunal is doing after the High Court has heard the case is to exercise its appellate powers under section (1)  29T.T.R.118                             547 33.......... The shape that the appeal would ultimately take and   -the  decision  that  the  Appellate  Tribunal   would ultimately give would entirely depend upon the view taken by the High Court."’ This  passage  was  quoted with approval by  this  Court  in Esthuri Aswathiah v. The C.I.T., Mysore(1).  In the  present case,  the High Court has held, and we agree with  the  High Court,  that  the  judgment of  the  Appellate  Tribunal  is vitiated  in  law because it has proceeded on  an  erroneous interpretation  of the statute.  The High Court  accordingly answered the third question in the affirmative and in favour of  the respondent-company.  We must make it clear that  the

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answer  of  the High Court to this question means  that  the Appellate Tribunal must now, in conformity with the judgment of the High Court, act under s. 66(5) of the Act, that is to say,  dispose  of the case after rehearing  the  respondent- company  and the Commissioner in the light of  the  evidence and according to law. Subject  to  this direction, the appeal  is  dismissed  with costs. R.K.P.S.                                              Appeal dismissed. (1) Civil Appeal No. 631 of 1966, decided on April 18, 1967. 548