C.P. Syndicate Private Ltd. vs Commissioner of Income Tax

S.P. Bharucha, J.—In this reference u/s 66(1) of the Indian Income Tax Act, 1922, we are called upon to answer, for the assessment year 1953-54, one question at the instance of the Revenue and for the assessment year 1954-55, one question at the instance of the assessee. The questions arise out of a common judgment and order of the Income Tax Appellate Tribunal. They read thus :

"1. Whether, on the facts and in the circumstances of the case, in considering the application of section 23A(1) to the company for the assessment year 1953-54 by reference to its past losses, the amounts lying to the credit of the reserve account of the company could be set off against the past losses ?

Whether, in view of the past losses and the pending claims in various litigations against the assessee company, a declaration of a dividend for the assessment year 1954-55 would have been reasonable ?"

The assessee is a private limited company doing business in mining. The total income of the assessee was determined at Rs. 9,54,825 for the first of the two aforementioned years and Rs. 7,16,452 for the second of those years. The assessments were modified in appeal and at the time the Tribunal passed the order, the income for the first year had been determined to be Rs. 7,48,183 and for the second year at Rs. 6,49,034. According to the statement of accounts of the assessee, there was a net profit of Rs. 5,40,589 for the first year and Rs. 7,08,830 for the second year. The assessee''s profit and loss account, as brought forward from the earlier years, showed an opening debit balance of Rs. 1,74,239 as on April 1, 1952. In the profit and loss account there was, accordingly, a credit balance of Rs. 3,66,118 as on March 31, 1953, and Rs. 7,36,605 as on March 31, 1954. The assessee''s paid up capital stood at Rs. 4,43,000 throughout the relevant period and its reserves at Rs. 10,40,385. Its contingent liabilities stood, according to its balance-sheet, at Rs. 1,56,942 as on March 31, 1953, and on March 31, 1954. A suit had already been filed on March 30, 1954, against the assessee making a claim for the sum of Rs. 12,50,000.

The assessee did not declare any dividend for the two years we are concerned with. The Income Tax Officer invoked the provisions of section 23A(1) of the Indian Income Tax Act, 1922, for both the years. The assessee preferred appeals and the Appellate Assistant Commissioner confirmed the Income Tax Officer''s orders. The assessee then approached the Tribunal.

The controversy before the Tribunal related to the following four aspects : (1) in determining the commercial profits or losses for the relevant years and earlier years, whether deductions had to be given on account of secret commission that had been paid; (2) in determining such commercial profits, whether the depreciation on fixed assets to be considered was the depreciation charged by the assessee in its accounts or the depreciation allowed by the Income Tax authorities in the assessments for those years; (3) in judging the reasonableness of the non-declaration of dividends by reference to the past losses of the assessee, whether the reserves of the assessee had to be taken into account; (4) in judging such reasonableness, whether contingent liabilities of the assessee had to be taken into account.

The Tribunal held that the secret commission had to be deducted in determining the commercial profits. It held that only the depreciation that had been charged by the assessee in its accounts could be taken into account. With these aspects we are not concerned in this reference.

The Tribunal rejected the claim made on behalf of the Revenue that the assessee''s reserves should be set off against the commercial losses of earlier years before deciding whether it was reasonable to expect it to declare a dividend. In so doing, the Tribunal relied upon the judgments of this court in Bombay Cycle Stores Co. (P.) Ltd. Vs. Commissioner of Income Tax, Nagpur, , and in Jubilee Mills Ltd. Vs. Commissioner of Income Tax, Bombay City I, . Tribunal noted that in the assessee''s case, the reserves had been kept intact and the losses had been brought forward in the profit and loss accounts from year to year. In these circumstances, it held, that past losses could not be ignored by reason only of the fact that the reserves that were brought forward were more than the losses incurred.

The Tribunal rejected the contention of the assessee that, having regard to its contingent liabilities, it would have been unreasonable for it to declare a dividend. It referred to the fact that the assessee had book debts considered good amounting to Rs. 5,10,071. It had an amount of Rs. 5,50,092 lying in a current with a connected company. It had advances amounting to Rs. 1,26,634. Its cash and bank balances stood at Rs. 66,576. The official liquidator owed it Rs. 1,48,116. It reserves were Rs. 10,40,385. These were relevant considerations in determining the capacity of the assessee to declare dividends, especially when there were sizeable commercial profits and only some contingent liabilities were put forward as a ground for withholding dividends.

The aspect of the setting off of the reserves against commercial losses is the subject matter of the first question that we are called upon to answer. The aspect of the contingent liabilities is the subject-matter of the second question.

It is convenient to set out, first, the provisions of section 23A(1) as it read :

"23A. Power to assess individual members of certain companies. - (1) Where the Income Tax Officer if 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 sixty per cent. 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 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 approach which must be adopted when applying the provisions of section 23A was laid down by the Supreme Court in Commissioner of Income Tax, West Bengal Vs. Gangadhar Banerjee and Co. (Private) Ltd., . The Supreme Court said that the Income Tax Officer acting u/s 23A was not assessing income to tax. He had to put himself in the place of the directors. Though the object of the section was to prevent evasion of tax, the provision had to be worked, not from the standpoint of the tax collector, but from that of a businessman. The yardstick was that of a prudent businessman. The reasonableness or unreasonableness of the amount distributed as dividend had to be judged by business considerations, such as previous losses, present profits, availability of surplus money, the reasonable requirements of the future and other similar considerations, in other words, the overall picture of the financial position of the business.

Approving these observations in Commissioner of Income Tax, (Central), Calcutta Vs. Asiatic Textiles Ltd., , the Supreme Court added that "it was not open to the Income Tax Officer to constitute himself as a super-director."

We find that the aspect of reserves, the subject-matter of the first question, is squarely covered by the decision of this court in Bombay Cycle Stores Co. (P.) Ltd. Vs. Commissioner of Income Tax, Nagpur, . The Tribunal there had taken the view that the amount of loss incurred by the assessee in earlier years need not be taken into account because there were accumulated reserves which exceeded the amount of the loss. In the opinion of this court, that was not a proper approach. Section 23A required the losses incurred in the previous year to be taken into account in considering the question of the reasonableness of the distribution of a dividend by the company. Whether the loss of the previous year should be adjusted against by the profits of the current year or it should be adjusted against the reserves was for the businessman to consider. It was not for the Income Tax Officer to direct the businessman in regard to the manner in which he should conduct his business. If the businessman chose to adjust the loss in the previous year against the profits of the current year, he was within his rights to do so and that had to be taken into consideration in deciding whether an order u/s 23A should be made. The Tribunal followed this decision in upholding the contention of the assessee and, in our view, was right in doing so.

Mr. Jetley, learned counsel for the Revenue, drew our attention to the judgment of the Madras High Court in Indo-Ceylon Dental and Surgical Co. Ltd. Vs. Commissioner of Income Tax, . This was a case in which the assessee had not declared dividend because, it contended, it was contemplating a manufacturing activity for which it had to build up sufficient finance. It was held that the fact that developmental activity was proposed did not show that the assessee wanted to build up reserves for such activity or that it was for that reason that a lesser dividend had been declared.

This decision of the Madras High Court does not assist us. It is not rendered in a case in which there had been losses in previous years and the directors had decided to set off the profits of the current year thereagainst. That was the position in the case of Bombay Cycle Stores Co. (P.) Ltd. Vs. Commissioner of Income Tax, Nagpur, .

The first question, accordingly, must be answered in favour of the assessee.

It is not in dispute that contingent liabilities can be taken into account in considering whether or not the provisions of section 23A should be applied

What was submitted by Mr. Dastur, learned counsel for the assessee, was that, having regard to the fact that the assessee had made losses in the past years and had contingent liabilities in the sum of Rs. 13 lakhs odd, it was not unreasonable that its directors should not declare a dividend for the year in question. Mr. Jetley, on the other hand, placed reliance upon the various figures which, as we have set out, had impressed the Tribunal and submitted that it was reasonable that, in the circumstances, the directors should not have declared a dividend and that, therefore, the provisions of section 23A had been rightly invoked.

Mr. Dastur relied upon the observations of the Supreme Court in CIT v. Jubilee Mills Ltd. [1968] 68 ITR 631. The Supreme Court said that a company which had got over its losses for some years and made a profit in the subsequent year might theoretically be in a position to distribute the whole of its profits for that year; but it could not 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.

As has been pointed out, it is not for the Income Tax Officer to appoint himself as a super director. He must consider the decision which has been taken by the directors objectively and in a businesslike manner, as if he was occupying their chairs. He must look at the matter with only the good of the business in mind. In the facts of the present case, considering that there had been losses over several consecutive years in the past and the contingent liabilities that might have to be met, a taxing authority, so looking at the matter, could not have concluded that the directors had acted unreasonably in not declaring dividend. The second question must, therefore, be answered in favour of the assessee.

In conclusion, the first question is answered in the negative and in favour of the assessee. The second question is also answered in the negative and in favour of the assessee.

There shall be no order as to costs.