Mugneeram Bangur and Co. vs Commissioner of Income Tax (Central), Calcutta

Mitter, J.—The questions referred to this Court u/s 66(1) of the income tax Act are as follows:

(1) Whether on the facts and in the circumstances of the case the sum of Rs. 59,650, Rs. 23,060 and Rs. 42,618 were deductible in computing the business profits of the Assessee for the assessment years 1951-52, 1952-53 and 1953-54 respectively?

(2) Whether the sums of Rs. 21,006, Rs. 14,221 and Rs 13,869 were income taxable under the Indian income tax Act for the assessment years 1951-52, 1952-53 and 1953 54 respectively?

The first question is not pressed and accordingly need not be considered.

With regard to the second question the facts are as follows: The Assessees are a registered firm dealing in shares and also acting as brokers, financiers and dealers in jute. The assessment years in question are 1951-52, 1952-53 and 1953-54, the relevant accounting years being Dewali years 2006-2007, 2007-2008 and 2008-2009. The income tax Officer included in the assessment for these three years three sums of Rs. 21,306, Rs. 14,221 and Rs. 13,869 being the amounts received from Messrs. Midnapur Zemindary Co. Ltd., holding that the receipts were in the nature of income because these were periodical monetary returns coming in with some sort of regularity or expected regularity from a definite source. The Appellate Assistant Commissioner agreed with the Income tax Officer relying on the decision of the House of Lords in the case of Inland Revenue Commissioners v. Trustees of Reid (1949) ITR Suppl. 41. Before the Tribunal it was contended that the payments made to the Assessees were not dividends in the ordinary sense of the terms, nor were they dividends in the special sense contemplated in Section 2(6A) of the Act which excluded capital gains earned outside certain periods from the accumulated profits for the purpose of determining whether any payment was made out of accumulated profits. It was further contended that dividend could only come out of current profits or accumulated profits and that the amounts received from Midnapur Zemindary Company were received from money received on share premium account and not from current profits or accumulated profits. The fund out of which these amounts were distributed was formed in the following way: From time to time Midnapur Zemindary Co. Ltd. issued shares at a premium to its members. The premium thus collected was first credited into a share premium account. They were afterwards transferred to a capital reserve account and it was from the capital reserve account that the payments to shareholders in the years in question were made. The income tax Officer relied strongly on the fact that the Assessees were dealers in shares and stocks and any amount'' received by them based on the share holding of Midnapur Zemindary Company must be treated as received in the nature of income. The Appellate Assistant Commissioner took the same view which was confirmed on appeal to the Tribunal.

The learned Standing Counsel appearing for the Assessees, very fairly placed before us all the relevant leading cases on this point. He made it clear that he did not wish to abandon his client''s contention pressed before the income tax authorities, but stated frankly that in view of the authorities he hardly expected the answer to come in favour of his client.

Before dealing, however, with the cases cited by counsel on either side, it will be useful to take a note of certain statements of law which are well-recognised and to which our attention was drawn from Palmer''s Company Law, 20th ed. Dealing with the question of divisible profits and profits available for dividend in chap. LXIV the learned author states at p. 637:

It is evident from the preceding observations that it is legally permissible for the Company to distribute dividend out of assets which do not represent profits made as the result of its trading or business. The connotation of divisible profits, or profits in the legal sense, is much wider than that of profits in the business sense; the former term includes, e.g., reserves accumulated from past profits, from realised capital profits, indeed, before the requirement of a share premium account by the 1947-1948 legislation from premiums obtained on issue of new shares, whereas none of these items is regarded and rightly so by the businessman or accountant as trading profits.

It will be noticed from the above that although the money collected by the company as premium on the issue of shares goes to form a capital reserve account, there was nothing to prevent a company in England before the 1947-1948 legislation and in India before the 1956 Act from distributing moneys out of the said fund which would come within the connotation of divisible profits.

In Inland Revenue Commissioner v. Reid''s Trustees (1949) A.C. 361 a question arose as to whether a distribution of capital profits realised on the sale of properties fell within the charging rules of Schedule D of the income tax Act of 1918 so as to be assessable under case ''V'' of Schedule D as income arising from possession out of the United Kingdom. The facts were as follows:

The Respondents were the trustees appointed to act under the settlement of one Joseph Reid, deceased in 1939. A sum of �6866 was received by them in December, 1943 from Reid Brothers (South Africa) Ltd., a company incorporated and registered in the Union (of South Africa in which the trustees held 3433 shares of �10 each fully paid. The remittance was received without deduction of income tax by the hands of one James M. Reid as paying agent in the United Kingdom for the company. The Commissioners for the Special Purpose of the income tax Acts found that the sum of �6866 was part of a distribution made by the directors of the company among the shareholders at the rate of �2 per share out of profits realised from the sale of capital assets, to wit, four properties in Johannesburg which belonged to the company and were, occupied by it as warehouse and office premises. The memorandum of association of the company showed that the objects for which the company was established were, inter alia, to carry on in South Africa or elsewhere all or any of the businesses of iron and steel merchants, wholesale and retail dealers of and in all apparatus and things required for mines and collieries. The business which was chiefly carried on was that of mine furnishers. The company was not authorised under its memorandum of association to trade in the buying and selling of property in land. In March, 1943, it owned four stands in Johannesburg, i.e., parcels of land for building whether or not any buildings were actually erected. When the properties were sold the estimated amount of profit on the sale �17451-19 s.-10d. was transferred to Profit and Loss Account from which it was transferred to a property suspense account. From this sum a dividend amounting to �15604 representing a 20% dividend was declared on October 23, 1943. The company had not been assessed to income tax in respect of this profit. This dividend so far as paid to shareholders in the United Kingdom, including the Respondents, was paid under deduction of United Kingdom, income tax which was accounted for by the paying agent. It was contended on behalf of the Crown that so long as the shares, the corpus of the trust estate remained intact, any remittance received by way of dividend in the United Kingdom was taxable as income arising out of possessions out of the United Kingdom; and secondly a life renter was entitled and only entitled to an income of the trust estate and therefore, anything received by him or ear-marked for him was necessarily income.

On behalf of the Assessees it was contended that in the case of a company within the United Kingdom it had always been accepted that if it sold part of its assets and a surplus arose which was distributed in cash, it was not liable to tax on the profit or gain arising to the shareholders from shares in the United Kingdom. It was further argued that there could not be a charge to income tax on any dividend paid out of such capital profits, as income tax was a tax upon income only and though the dividend may be of the nature of income, it was not taxable income. In the opinion of Lord Simonds it was begging the question to say that the sum received by the trustees was not income in the hands of the shareholders. According td his Lordship:

By every practical test it has proved to be income. I will assume that the money out of which the dividend was paid was capital in the hands of the company for the purpose, at any rate, of ascertaining its taxable profit. I think that the commissioners were entitled to find that as a fact; but it was not the fact and they were not entitled to find as a fact, that the dividend in the hands of a recipient shareholder was not his income.

His Lordship went on to say:

I think it should not be necessary to repeat what has so often been said in this House that the position of a company resident in the United Kingdom (I will call it an English company) and its shareholders is wholly different from that of a foreign company and its shareholders, who being resident here, are taxable in respect of income from their foreign possessions. The most striking difference, which itself cuts at the root of any argument based upon a disparity of treatment, is that a shareholder in an English company is not, but a shareholder in a foreign company is, directly assessable to tax in respect of the dividends that he receives.

Further on his Lordship said:

I must not be taken as suggesting any inaccuracy or insufficiency in the information which has in this case been furnished by the South African company, but it is obvious that as a general rule the Revenue authorities cannot have the same facilities for investigating the affairs of a foreign company and checking its statement that a dividend is paid out of ''capital profits''. They must work upon a broader basis and I cannot imagine a safer or better one,'' where the question is as to income arising from a foreign possession, than to ask whether the corpus of the asset remains intact in the hands of taxpayer. That question can in the case of the shares here in question only be answered in the affirmative. The shares the Respondents held before the distribution of dividend they still hold infact. The dividend they received was income arising out of those shares.

Lord Normand pointed out that

the payment was quite properly described as a dividend and a dividend is at least prima facie income of the recipient. In law capital cannot be returned to the shareholders by a mere money distribution whether called a dividend or by some other name and there was in this instance no return of capital. The shares of the company remained after the distribution intact and precisely as they were before it.

The question of division of capital profits to shareholders came up for consideration in the Court of Appeal in England in the cases Cenlon Finance Co. Ltd. v. Ellwood and Tableau Holdings Ltd. v. Williams (1961) 1 Ch. 634. The facts as taken from the judgment of Upjohn L.J. are as follows:

Tableau Holdings Ltd. was incorporated in November, 1952, as a finance company a company trading in stocks and shares. Very soon thereafter it acquired the whole of the issued capital of a company known as Henry White (Sutherland House) Ltd. which carried on business as ladies'' outfitters. That company had sold some of its free-hold property at New Castle-under-Lyme and realised a profit which was a capital profit and had not been assessed to tax in its hands. The purchase consideration for the acquisition of its shares was �87909 and on the same day Henry White distributed by way of dividend to Tableau Holdings, as its sole shareholder, a sum of �18,000 out of the capital profit on the sale of its premises. Being a capital profit not subject to tax, no tax was deducted by Henry White when making the distribution.

On October 20, 1953, Tableau Holdings sold the whole of the issued share capital in Henry White to Cenlon Finance Co. Ltd. for the sum of �72,000. The operation was repeated and on November 2, 1953, Henry White made another capital distribution by way of dividend out of the profit on the sale of its premises to Cenlon of �25,000, again without deduction of tax. On December 4, 1953, Cenlon sold its entire holdings of shares in Henry White for �27,500. Cenlon, like Tableau Holdings, was incorporated to carry on the business as a finance company or dealer in stocks and shares. The question before the Court was whether dividends declared by Henry White and paid to Tableau Holdings and Cenlon respectively ought to be brought in as a credit in assessing the profits of the respective companies'' trade. The question turned on the interpretation of Section 184 of the income tax Act, 1952. It was contended on behalf of the taxpayer that there was no provision in the income tax Acts which provided for the taxation of dividends declared by companies save as provided by that section. This was rejected by Upjohn L.J. who observed:

Section 184 is not a charging section and has no analogy with the charging schedules contained in the income tax Acts. It is to be found in Part VII of the Act and is a machinery or administrative provision and is directed solely to the case where a company is paying a dividend out of profits charged to tax and is authorised (though not compellable) to deduct the tax from the dividend.... In the ordinary case, a company pays dividends out of profits brought into charge for tax and deducts the tax. No difficulty arises. If a company (as in this case) such as Henry White makes a capital profit, then it is not entitled to deduct the tax u/s 184 and there is no provision in the income tax Acts whereby the recipient can automatically be assessed to tax on the dividend. Those are the ordinary cases; but this is a case where the company assessed is a trader in stocks and shares. I can see nothing myself to prevent the application of the ordinary rules, that is to say, the company is assessed under Case I of Schedule D on the profit made from dealing in stocks and shares and it has to bring in profits that it makes on dealings which in the hands of a non-trader would be capital profits; for example, the profit made on the sale of a share over the purchase price; a cash repayment on a reduction of capital; dividends received in a liquidation all these would be capital profits in the hands of the non-trader. But the trader has chosen to regard his stocks and shares as his stock-in-trade and he deals with them as such and the fruit which is yielded by such dealings is the fruit of his trade and is assessable to tax under Case I of Schedule D.

To the same effect are the observations of Donovan L.J.:

Dividends are not, as such liable to be assessed to income tax because of anything in Section 184, but because the Law recognises that while a company is one person and its shareholder is another, nevertheless no new fund of profit is created merely by dividing that fund. But where the dividend comes to a person who is not merely a shareholder but a trader and the dividend is income of the trade he carries on, why should the Act not be obeyed and the dividend included in the computation of those profits to be taxed as profits of the trade?

This was upheld in appeal to the House of Lords (1962) A.C. 782. Lord Reid pointed out:

The dividend in question was received as income and is for ordinary commercial or accounting purposes a trading receipt. Therefore, it cannot be left out of account in computing the Appellant''s profits for income tax purposes unless there is some good ground in law for doing so.

A very recent judgment on this point is to be found in Bicber Ld. v. Commissioner of income tax (1962) 3 A.E.R. 294. Here, a company incorporated in the United Kingdom and carrying on business in British Guiana, owned 600 shares in Rupununi Development Co. Ltd., a company incorporated in British Guiana. That company by the sale of some property made a profit, which was admittedly a capital profit. It transferred its profit to a capital reserve account from which it paid dividend of $ 2 per share. The Commissioners of income tax in British Guiana treated the dividend as investment income. The Appellant company unsuccessfully appealed to Date, J. who confirmed the assessment. The Full Court of the Supreme Court, however, reversed its decision. The Commissioners of Income tax then appealed successfully to the Federal Supreme Court of the West Indies, who restored the judgment of Date, J. The matter was ultimately brought before the Judicial Committee by the Assessee. The question turned on the interpretation of Section 5 of the income tax Ordinance of British Guiana which provided:

income tax, subject to the provisions of this ordinance, shall be payable at the rate or rates herein specified for each year of assessment upon the income of any person accruing in or derived from the colony or elsewhere and whether received in the colony or not, in respect of...(c) dividends, interest or discounts.

In delivering the judgment of the Judicial Committee Lord Pearce observed:

The words ''in respect of'' are not felicitous but can mean no more than ''consisting of or ''namely''. It is agreed on both sides that unless the dividend was received as income in the hands of the tax-payer it does not attract tax. Counsel for the Appellant argues that it came from a fund that was capital in the hands of the payer and that nothing has happened to convert it into income in the hands of the recipient.

Referring to the judgment in the case of R.A. Hill v. Permanent Trustee Co. of New South Wales Ltd. (1930) A.E.R. 87 Lord Russell of Killowen said:

A limited company not in liquidation can make no payment by way of return of capital to its shareholders except as a step in an authorised reduction of capital. Any other payment made by it by means of which it parts with moneys to its shareholders must and can only be made by way of dividing profits. Whether the payment is called ''dividend'' or ''bonus'' or any other name, it still must remain a payment on division of profits. Moneys so paid to a shareholder will (if he be a trustee), prima facie, belong to the person beneficially entitled to the income of the trust estate.

His Lordship held that the sum received by the tax-payer was income in the nature of dividends.

In this case, the Assessees being dealers in stocks and shares, the amount received was by way of income accruing in respect of those shares of Midnapur Zemindary Co. Ltd. The capital structure of Midnapur Zemindary Co. Ltd. remained undisturbed after the distribution of the moneys from time to time. Although the funds held in share premium accounts from time to time (capital reserve account) was capital in the hands of Midnapur Zemindary Co. Ltd. they became income in the hands of the Assessees who were dealers in stocks and shares and consequently the Assessees cannot be heard to say that the amounts are not taxable.

The second question must, therefore, be answered in the affirmative and against the Assessees who will pay the costs of this reference.

Masud, J.

I agree.