Commissioner of Income Tax vs Bert and Company Pvt. Ltd.

Venugopal, J.—The assessee is a private limited company and is the managing agents of M/s. Anglo Textiles Ltd. The paid up capital of the

assessee company is Rs. 4,00,000 consisting of 8,000 equity shares of Rs. 50 each, held by 500 share-holders. As the managing agents of M/s.

Anglo French Textiles Ltd., the assessee, had to guarantee loans taken by the managed company from banks and third parties for purposes of its

business, it had guaranteed loans of Rs. 25,50,000 of the managed company as on 31-12-1964, Rs. 39,50,000 as on 31-12-1965 and of Rs.

59,50,000 as on 31-12-1966. The assessee company made a profit of Rs. 3,39,239.86 for the accounting year ending 31-12-1964, and Rs.

3,09,429.43 for the accounting year ending 31-12-1965. Out of the profits of the accounting year ending 31-12-1964 a sum of Rs. 2,25,000 was

transferred to the general reserve. Similarly a sum of Rs. 1,80,000 from out of the profits for the year ending 31-12-1965 was transferred to the

general reserve. For the asst. yrs. 1965-66 and 1966-67, no dividend was declared by the assessee company. The ITO came to the conclusion

that there was no justification for the assessee company in not declaring the dividend for the asst. yrs. 1965-66 and 1966-67 and accordingly

passed an order u/s 104 of the IT Act, 1961 for the two assessment years in question. The AAC held that even assuming tax was chargeable u/s

104, the assessee was entitled to the concession available under paragraph 8 of the Pondicherry (Taxation Concession) Order of 1964. On a

further appeal, the Tribunal held that the assessee company had guaranteed loans taken by the managed company from bank and third parties to

the tune of Rs. 25,50,000 as on 31-12-1965 and it had reserved only to the extent of Rs. 12,75,000 as on 31-12-1963 and it was, therefore,

necessary for the assessee company to build up reserves in order to be in a position to meet the guarantee obligations and the reserves of Rs.

16,86,000 as on 31-12-1965 was only a little over 40 per cent. of the loans guaranteed as on that day and hence the assessee company was

justified in not declaring dividend for the accounting year ending 31-12-1964 and 31-12-1965. At the instance of the Revenue, the following

questions of law have been referred to this Court for opinion u/s 256(1) of the IT Act, for the asst. yrs. 1965-66 and 1966-67.

For the asst. yr. 1965-66 :

(i) Whether, on the facts and in the circumstances of the case, the Appl. Tribunal was right in holding that the assessee was not liable to additional

tax u/s 104 of the IT Act for the asst. yr. 1965-66 ?

(ii) Whether, on the facts and in the circumstances of the case, the Appl. Tribunal was right in holding that the assessee company was justified in

not declaring the dividend for the asst. yr. 1965-66 ?

(iii) Whether the Appl. Tribunal''s finding, that the declaring of a dividend in the assessee''s case would be unreasonable, is based on relevant and

valid consideration and is sustainable in law ?

(iv) If the answers of the above questions are in the negative, whether, the assessee company is entitled to the benefit of concession available under

paragraph 8 of the Pondicherry (Taxation Concession) Order ?

For the asst. yr. 1966-67 :

(i) Whether, on the facts and in the circumstances of the case, the Appl. Tribunal was right in holding that the assessee was not liable to additional

tax u/s 104 of the IT Act for the asst. yr. 1966-67 ?

(ii) Whether, on the facts and in the circumstances, the Appl. Tribunal was right in holding that the assessee company was justified in not declaring

dividend for the asst. yr. 1966-67 ?

(iii) Whether the Appl. Tribunal''s finding, that the declaring of a dividend in the assessee''s case would be unreasonable, is based on relevant and

valid considerations and is sustainable in law ?

(iv) If the answer to the above questions are in the negative, whether, the assessee company is entitled to the benefit of concession available under

para 8 of the Pondicherry (Taxation Concession) Order ?

The ld. counsel for the Revenue contended that there is no positive material to show that the Board of Directors resolved to declare no dividend

with a view to build up sufficient reserve to meet their obligations as guarantors for the loans taken by the managed company from banks and third

parties for the purpose of its business and the financial position of the managed company was such that it was itself capable of discharging all its

debts and obligations and the assessee company increasing its reserve without declaring dividend cannot be construed as an act of prudent

businessman and there is every justification for the ITO to pass the order u/s 104 for the two assessment years in question. In support of this

contention, the ld. counsel for the Revenue relies on a decision of this court reported in Indo-Ceylon Dental and Surgical Co. Ltd. Vs.

Commissioner of Income Tax, and Commissioner of Income Tax Vs. Anamalai Bus Transports (P.) Ltd., .

The Supreme Court in the decision reported in Commissioner of Income Tax, West Bengal Vs. Gangadhar Banerjee and Co. (Private) Ltd.,

has pointed out that the reasonableness or unreasonableness of the amount distributed as dividend is to be judged by business considerations, such

as the previous losses, the present profits, the availability of surplus money and the reasonable requirements and the ITO must take an overall

picture of the financial position of the business putting himself in the position of a prudent businessman or the Director of a company and deal with

the problem with a sympathetic and objections approach. In the decision reported in Commissioner of Income Tax, (Central), Calcutta Vs. Asiatic

Textiles Ltd., the Supreme Court has pointed out that whether in a particular year dividend should be declared or not is a matter primarily for the

directors of the company and the ITO can step in only if the directors unjustifiably refrained from declaring the dividend and if the directors have

reasonable grounds for not declaring any dividend it is not open for the ITO to constitute himself as super-director. In view of these decisions cited

above, it is obvious that the reasonableness or unreasonableness of the amount distributed as dividend is to be judged primarily by business

consideration and the reasonable requirements of the future taking an overall picture of the financial position of the business and the provision must

be worked out not from the stand point of the tax collector but from that of a prudent businessman and the provision must be worked out by the IT

department in a sympathetic manner. In the instant case, by entering into a contract of guarantee, the assessee has become a surety for the liabilities

of its managed company and though the surety''s obligation may be substantially dependent on the default of the managed company, the principal

debtor, yet, the assessee has to keep itself in readiness to fulfil the obligation that may arise under the contract of guarantee. In order to face any

such contingent liabilities that may arise on the contract of guarantee the assessee without declaring dividend from the profits realised, has

appropriated if for the creation of a reserve to meet any possible unforeseen contingency arising out of the contract of guarantee for the loans taken

by the managed company from banks and third parties. For this purpose the assessee has to necessarily build up adequate resources in the form of

reserves. The creation of adequate reserve by the assessee company to meet unforeseen possible contingencies arising out of the contract of

guarantee is a reasonable requirement of the future needs and contingencies of the assessee company. Even granting that the managed company

had sufficient assets to meet its financial obligations, it does not detract the assessee company from keeping itself in readiness to fulfil its future

obligations that may arise under the contract of guarantee. The ld. counsel for the revenue contended that there is no material like the resolution of

the Board of Directors to show that dividend was not declared with a view to build up sufficient reserve to meet contingencies that may arise out of

the contract of guarantee given by the assessee company, and in the absence of such material, the Tribunal was not justified in coming to the

conclusion that no dividend was declared because of the need to build up adequate reserves to meet the obligation that may arise under the

contract of guarantee. It is not in dispute that the guarantees were in the normal course of business and the reserve created by the assessee

company as on 31-12-1964 was only a little over 40% of the amount guaranteed as on that date. Viewed against the background of these facts,

the only reasonable and possible inference which can be drawn, and which has been rightly drawn, by the Tribunal was that non-declaration of the

dividend by the assessee company was only on account of the need to build up adequate reserve to meet possible contingent liabilities that may

arise under the contract of guarantee entered into by the assessee company guaranteeing the debts of its managed company. The Tribunal was,

therefore, justified in coming to the conclusion that dividend was not declared by the assessee company because of its need to create adequate and

sufficient reserve to meet any possible commitment that may arise under the contract guaranteed.

All the questions for the two assessment years in question are, therefore, answered in the affirmative and in favour of the assessee. The assessee

is entitled to the cost of reference. Counsel''s fee Rs. 500 (one set).