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PETITIONER: COMMISSIONER OF INCOME-TAX, WEST BENGAL,CALCUTTA

       Vs.

RESPONDENT: GUNGADHAR BANERJEE AND CO. (P) LTD.

DATE OF JUDGMENT: 22/03/1965

BENCH: SUBBARAO, K. BENCH: SUBBARAO, K. SHAH, J.C. SIKRI, S.M.

CITATION:  1965 AIR 1977            1965 SCR  (3) 439  CITATOR INFO :  E          1968 SC 883  (6)  R          1973 SC2323  (9)  RF         1976 SC 255  (21)  R          1990 SC1277  (29)

ACT: Indian  Income-tax Act, 1922 (11 of 1922), s.  23A-Dividend- Distribution-Burden of showing whether low-Circumstances  to be considered--"Smallness of profit"-Meaning  of-"Accounting profits" and "assessable profits", distinction between.

HEADNOTE: As   the  dividend  declared  to  be  distributed   by   the respondentcompany  at its General Body Meeting was below  60 per  cent  of the profits available  for  distribution,  the Income-Tax  Officer,  with  the  previous  approval  of  the Inspecting Assistant Commissioner, passed an order under  s. 23-A  of the Income-Tax Act directing that a certain  higher amount shall be deemed to have been distributed as dividends as on the date of the annual general meeting of the Company. He  found that, having regard to the profits earned  in  the earlier years and the capital and taxation reserves, payment of  larger  dividend would not be  unreasonable.   This  was affirmed,  on assessees appeals by the  Appellate  Assistant Commissioner,  and the Income-tax Appellate  Tribunal.   The Tribunal referred the question to the High Court under  sec. 66(1) of the Act, which concluded that having regard to  the smallness  of  the  profits, the  order  of  the  Income-tax Officer  was not justified and answered the question in  the assessee’s favour.  In appeal by certificate. HELD:     Section 23A of the Income-tax Act is in the nature of  a  penal  provision.   In  the  circumstances  mentioned therein, the entire undistributed portion of the  assessable income  of  the  company  is deemed  to  be  distributed  as dividends.   Therefore, the Revenue has strictly  to  comply with  the  conditions  laid  down  thereunder.   The  burden therefore, was upon the Revenue to prove that the conditions laid  down thereunder were satisfied, before the  order  was made. Thomas Fattorini (Lancashire) Ltd. v. Inland Revenue Commis- sion L.R. [1942] A.C. 643 applied.

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In the present case the Revenue failed to discharge the said burden: indeed, the facts established stamp the order of the Income-tax Officer as unreasonable.. [446F, G] Though  the object of the section is to prevent  evasion  of tax,  the provision must be worked not from the stand  Point of  the tax collector but from that of a  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. 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.   It  is difficult to say 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 in s. 23A of the Act. [444B-E] 440 Commissioner of Income-tax v. Williamson Diamond Ltd.   L.R. [1958] A.C. 41, applied. Sir  Kasturchand Ltd. v. Commissioner of Income-tax,  Bombay City, (1949) 17 I.T.R. 493, referred to. The  words "smallness of profit" in s. 23A of the Act  refer to   actual  accounting  profits  in  comparison  with   the assessable   profits   of  the  year.   The   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. [445F-H.] Commissioner  of  Income-tax, Bombay  City  v.  Bipinchandra Maganlal and Co. Ltd. (1961)41 I.T.R. 296, followed. In a case where an Income-tax Officer takes action under  s. 23A  of  the Act before the tax for the relevant  period  is assessed, only the estimated tax can be deducted; but, there is  no  reason why, when the tax had already  been  assessed before he takes action under this section. the estimated tax and  not  the real tax shall be deducted  therefrom.  [445H- 446B] There is no provision in the Income-tax Act which makes  the Balance Sheet final for the purpose of s. 23A of the Act  or even for the assessment.  It no doubt affords a prima  facie proof  of the financial position of the company on the  date when  the dividend was declared.  But nothing  prevents  the parties  in a suitable case to establish by cogent  evidence that  certain  items were, either by mistake or  by  design, inflated  or  deflated or that there  were  some  omissions. [446B-D]

JUDGMENT: CIVIL APPELLATE JURISDICTION: Civil Appeal No. 807 of 1963. Appeal  from the judgment and order dated September 4,  1961 of  the Calcutta High Court Income-tax Reference No.  85  of 1956. C.K. Daphtary, Attorney General, R. Ganapathy Iyer and R.   N. Sachthey, for the appellant. A.   V.  Viswanatha  Sastri  and S.  C.  Muzumdar,  for  the respondent.

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The Judgment of the Court was delivered by Subba Rao, J. This appeal by certificate raises the question of  the  construction  of the provisions of s.  23A  of  the Indian  Incometax  Act, 1922, hereinafter  called  the  Act, before it was amended by the Finance Act, 1955. The  relevant  and undisputed facts may be  briefly  stated. Messrs.   Gungadhar  Banerjee  &  Co.  (Private)  Ltd.,  the respondent  herein,  is a private limited company.   At  the General  Body  Meeting of the Company held  on  December  6, 1948, the Directors declared a dividend at the rate of 5 1/2 per  cent.  per share.  The said distribution  of  dividends related to the accounting year 1947-48 which ended on  April 13, 1948.  According to the balance-sheet of the Company for that  year  the  net  profit  for  the  said  year  was  Rs. 1,28,112/7/5.   The  taxation reserve was Rs.  56,000.   The profit 441 left  was Rs. 72,000.  The Directors declared a dividend  at the  rate  of  51 per cent. per share thus  making  a  total distribution  of Rs. 44,000.  On that basis the profit  that was  available  for  further distribution  was  Rs.  28,000. Though  under  the balance-sheet the estimated tax  was  Rs. 66,000,  the tax assessed for the year was Rs.  79,400.   If the  difference between the tax assessed and  the  estimated tax was also deducted from the profits, there would only  be a  sum  of  Rs. 4,000 that  would  remain  as  undistributed profits. The  Income-tax  Officer assessed the total  income  of  the assessee  for  the  year 1948-49  at  Rs.  2,66,766.   After deducting the tax payable under the two heads, namely,  I.T. of Rs. 81,517/13/0 and C.T. of Rs. 33,345/12/0, he held that a sum of Rs. 1,51,902/7/0 was available for distribution  to the shareholders as dividends.  As the amount distributed by the Company was below 60 per cent. of the profits  available for distribution, the Income-tax Officer, with the  previous approval of the Inspecting Assistant Commissioner of Income- tax, passed an order under s. 23-A of the Act directing that the  amount  of Rs 1,07,902 (i.e., Rs.  1,51,902  minus  Rs. 44,000=   Rs.  1,07,902)  shall  be  deemed  to  have   been distributed  as  dividends  as on the  date  of  the  annual general  meeting  of  the Company.  He  found  that,  having regard  to the profits earned in the earlier years  and  the capital  and taxation reserves, payment of larger  dividends would not be unreasonable. The assessee preferred an appeal to the Appellate  Assistant Commissioner  against  the  order  made  by  the  Income-tax Officer  under  s. 23A of the Act.  By the time  the  appeal came  to be disposed of, in an appeal against the  order  of assessment  the assessed income was reduced by a sum of  Rs. 80,926.   Notwithstanding the said deduction, as the  amount of  Rs. 44,000 distributed by the Company was less  than  60 per  cent. of the balance of Rs. 1,64,440 arrived at on  the basis  of the revised calculation, the  Appellate  Assistant Commissioner held that an action under s. 23A of the Act was justified.   He  further held that the assesee  incurred  no losses  in the previous years, that in almost all  the  past assessments  the assessee showed substantial  profits,  that the profits disclosed in the year of account were not  small and that, therefore, the direction to pay a higher  dividend was not unreasonable. On a further appeal, the Income-tax Appellate Tribunal  held that  the amount of profits should be judged only  from  the balancesheet and that judged by the figures given thereunder a dividend to the extent of Rs. 64,000 being 60 per cent. of the  assessed profits less income-tax. could be  distributed

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and that such distribution was not unreasonable. The Tribunal referred the following question under s.  66(1) of the Act for the decision of the High Court of Calcutta:               "Whether on the facts and in the circumstances               of  the  case any larger  dividend  than  that               declared  by the company could  reasonably  be               distributed within the meaning               442               of  Section 23A of the Indian  Income-tax  Act               and  the  application of Section  23A  of  the               Indian  Income-tax Act was in accordance  with               law." The  High Court held that the Tribunal went wrong in  taking into  consideration  the past profits instead  of  the  past losses,  the taxation reserves without considering the  past liabilities  for taxation, and the profits for the  year  in question disclosed in the balance-sheet, ignoring the actual tax assessed for that year.  It came to the conclusion that, having regard to the smallness of the profits, the order  of the Income-tax Officer was not justified.  In the result, it answered  both parts of the question referred to it  in  the negative.  Hence the appeal. Learned  Attorney-General, appearing for the  Revenue,  con- tended  that the balance-sheet of a company on the basis  of which  dividends  were declared was final  and  the  profits disclosed  thereunder  would be the correct  basis  for  the Income-tax  Officer acting under s. 23A of the Act; 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 s. 23A of  the Act.   Alternatively  he contended that  if  the  respondent could  be  permitted  to  go  behind  the  balance-sheet  to ascertain  the  real profit, the Department should  also  be likewise allowed to go behind the balance-sheet to show that the  commercial profit was larger and the reserves  were  in excess  of  the past liabilities and that in that  event  to remand the case for ascertaining the true state of facts. Mr. A.V. Viswanatha Sastri, appearing for the  assessee-Com- pany,  contended  that  the burden lies on  the  Revenue  to establish  that the dividend declared was not  a  reasonable one and that in the present case it had not discharged  that burden.   Idle  further  argued  that  for  the  purpose  of "testing the smallness of the profit" the Income-tax Officer had to take into consideration not the assessable Income but the commercial profit of the Company and that in the present case, having regard to the commercial profit, a  declaration of  a  higher dividend would be  unreasonable.   He  pleaded that,  should  this Court hold that the  Income-tax  Officer could  establish  that  the  reserves  were  more  than  the liabilities, the assessee should also be permitted to  prove what were its real, commercial profits and that the reserves were far less than the demands. The contentions of learned counsel turn upon the  provisions of s.     23A  of  the  Act, before it was  amended  by  the Finance  Act  of 1955.  The material part  of  that  section reads:               "(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 up to the end of the               443               sixth  month  after  its  accounts  for   that

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             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  incometax  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  un-               distributed  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  section is in three parts: the first part  defines  the scope  of the jurisdiction of the Income-tax Officer to  act under  s. 23A of the Act; the second part provides  for  the exercise  of  the  jurisdiction  in  the  manner  prescribed thereunder-, and the third part provides for the  assessment of  the  statutory  dividends in the hands  of  the  share.- holders.    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  loss  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 centered 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 444 accounting profits?  If the scope of the section is properly appreciated  the  answer  to the  said  questions  would  be apparent.  The Incometax Officer, acting under this section, is not assessing any income to tax: that will be assessed in the  hands  of  the shareholders.  He  only  does  what  the directors should have done.  He puts himself in the place of

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the directors.  Though the object of the section is to  pre- vent  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. On the interpretation of the words "having regard to" in  s. 23A  of  the Act, the decision of a Division  Bench  of  the Bombay High Court, consisting of Chagla C. J., and Tendolkar J.,  in Sir Kasturchand Ltd. v. Commissioner of  Income-tax, Bombay  City(1)  was relied upon by the  appellant.   Chagla C.J.,  speaking for the Court, held in that case  that  "the reasonableness  or  unreasonableness  of the  payment  of  a dividend  or  a larger dividend has to be judged  only  with reference  to the two facts mentioned in the section,  viz., losses  incurred  by the company in earlier  years  and  the smallness of the profit." To put the contrary  construction, the learned Chief Justice said, "would be to import into  it words  which the Legislature did not think fit to insert  in that  section  and  to expand the ambit  of  the  discretion exercised by the Income-tax Officer." But the learned  Chief of  Justice  did  not expressly consider the  scope  of  the expression  "having  regard to" found in the  section.   The Judicial   Committee  in  Commissioner  of   Income-tax   v. Williamson  Diamond Ltd.(2) had to consider the scope of  s. 21(1)   of   the   Tanganyika   Income-tax   (Consolidation) Ordinance, 27 of 1950, which was pari materia with s. 23A of the  Act.   Adverting to the argument based upon  the  words "having regard to", their Lordships observed:               "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               (1)   [1949] 17 I.T.R. 493.               (2)   L.R. [1958] A.C. 41.49.               445               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 profits"  are  never               lost  sight of, requires all matters  relevant

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             to  the  question of  unreasonableness  to  be               considered.   Capital losses, if  established,               would be one of them." With  great respect, we entirely agree with this view.   The contrary view unduly restricts the discretion of the Income- tax  Officer and compels him to hold a  particular  dividend reasonable though in fact it may be unreasonable. The expression "smallness of profit" came under the judicial scrutiny of this Court in Commissioner of Income-tax, Bombay City  v. Bipinchandra Maganlal & Co. Ltd.(1) Therein,  Shah, J., speaking for the Court observed thus:               "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.   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 is  to be  judged  in  the  light of the profits  of  the  year  in 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. Another  incidental question is whether for the  purpose  of ascertaining the net commercial profits the tax estimated or the  tax  actually assessed shall be deducted.   In  a  case where an Income-tax Officer takes action under s. 23A of the Act before the tax for the relevant period is assessed, only the estimated tax can be deduct- (1) (1961) 41 T.T.R. 290, 296, p(N)4SCI- 446 ed  but,  there is no reason why, when the tax  had  already been assessed before he takes action under this section, the estimated  tax  and  not  the real  tax  shall  be  deducted therefrom.   In this view, in the present case to  ascertain the  commercial profits what should be deducted is  not  the tax shown in the balance-sheet but the actual tax  assessed, on the income of the Company. Another  question  raised is whether  the  balance-sheet  is final  and both the parties are precluded  from  questioning its  correctness in any respect.  There is no  provision  in the  Income-tax Act which makes the balance-sheet final  for the purpose of s. 23A of the Act or even for the assessment. It  no  doubt affords a prima facie proof of  the  financial position  of the company on the date when the  dividend  was declared.   But nothing prevents the parties in  a  suitable case  to  establish by cogent evidence  that  certain  items were,  either by mistake or by design, inflated or  deflated or  that  there  were  some omissions.   It  does  not  also preclude  the  assessee from proving that  the  estimate  in

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regard  to  certain  items has turned out to  be  wrong  and placing  the actual figures before the  Income-tax  Officer. But in this case no attempt was made before the Tribunal  to canvass  the correctness of the figures either on the  debit side  or  on  the credit side and we do  not  think  we  are justified  to  give  another opportunity to  either  of  the parties  in this regard.  Before the Tribunal there  was  no dispute  that the actual tax assessed for the relevant  year was much higher than the estimated tax shown in the balance- sheet. Section  23A  of  the  Act  is in  the  nature  of  a  penal provision.   In  the  circumstances  mentioned  therein  the entire undistributed portion of the assessable income of the Company   is   deemed  to  be  distributed   as   dividends. Therefore,  the  Revenue  has strictly to  comply  with  the conditions  laid  down thereunder.  The  burden,  therefore, lies upon the Revenue to prove that the conditions laid down thereunder  were  satisfied before the order was  made:  see Thomas   Fattorini  (Lancashire)  Ltd.  v.  Inland   Revenue Commissioners(1).  In the present case the Revenue failed to discharge  the  said burden: indeed, the  facts  established stamp the order of the Income-tax Officer as unreasonable. The  assessment orders passed by the Income-tax Officer  are not before the Court.  The balance-sheet shows a net  profit of  Rs.  1,28,112/7/5  whereas the  Income-tax  Officer  has computed  the assessable income at Rs. 2,66,766,  which  was later reduced in appeal by Rs. 80,925.  There is no evidence on  the  record  that  the  real  commercial  profits   were artificially  reduced in the balance. sheet.  Nor  is  there evidence to show what part of the income assessed represents commercial  profits, and what part the notional income.   In the  circumstances  it  must  be  assumed  that  the  amount mentioned  in  the balance-sheet correctly  represented  the commercial profits. (1)  L.R. [1942] A.C.643. 447 From the figures already extracted at an earlier stage it is manifest that the net commercial profit was barely Rs. 4,000 and it is not possible to hold that it was not  unreasonable for  the Income-tax Officer to make an order to  the  effect that  the additional sum of Rs. 64,000 should be deemed,  to have been distributed as dividends amongst the shareholders. In  the result we hold that the order of the High  Court  is correct and dismiss the appeal with costs. Appeal dismissed. 448