V. Ramaswami Naidu and Another vs Commissioner of Income Tax, Madras

Balakrishna Ayyar, J.—u/s 66(1) of the Income Tax Act the Income Tax Appellate Tribunal of Bombay has referred the following question

for the decision of this Court;

Whether the assessment of the gross income from the investment in the aforesaid foreign company, before deduction of the Ceylon Income Tax

thereon, as having accrued in full, is valid and proper?

The material facts are these: V. Rama-swami Naidu, the Kartha of a Hindu undivided family, held in the names of various members of the family

10208 shares of Rs. 10 each in Agravas, Estates Ltd., a company incorporated in Ceylon. For purposes of the Indian Income Tax Act this

company is a foreign company, G. V. Govinda-swami Naidu another assesses, and. his wife, Govindarnmal, held 10,000 shares in the same

company between them. At a meeting of the general body of shareholders of this company held on 11-11-1950 certain dividends were declared

and subsequently paid in the manner and to the extent indicated below:

Gross dividends Ceylon Income Tax Net Dividends certificate

deducted dividends annexures,

(1) (2) (3) (4) (5)

Rs. Rs. Rs.

Ramaswami Naidu (Hindu 26,270 8,024 18,246 ""A-1, A-2 and A-3

undivided family). -

Govindaswami Naidu. 25,000 7.375 17,625 ""B-l and B-2

The previous year- of these two assessees was the Tamil year ended 13-4-1951. For the assessment year 1951-52 the Income Tax Officer

assessed the gross amounts of the dividends ignoring the Ceylon Income Tax that had been deducted therefrom. The assessees contended before

the Appellate Assistant Commissioner that it was only the net dividend that was assessable.

The Appellate Assistant Commissioner, however, confirmed the orders of the Income Tax Officer. The assessees then went up to the Income Tax

Appellate Tribunal. By its orders made on 22-7-1953 the Tribunal found--we are now quoting from paragraph 8 of the letter of reference-

That the income in question did not call for consideration as ''dividends,'' as the aforesaid foreign company was not registered under the Indian

Companies Act, and generally did not fall within the scope of Sections 2 (6), 2 (6) (a) and 16 (2) of the Income Tax Act but only as income from a

foreign investment; there was no provision in the Ceylon Income Tax Ordinance which distinguished the position of the tax deducted at source

from dividends from that envisaged in the scheme of the Indian Income Tax Act and that under both the enactments, the tax deducted was deemed

to be credited to the assessee and paid on his account.

On this reasoning the Tribunal rejected both the appeals.

The assessees then applied to the Tribunal that the question of law arising out of their contention be referred to this court. The Tribunal agreed

that a point of law arose and hence referred the question to this court.

Certain provisions of the Ceylon Income Tax Ordinance must now be referred to. Sub-section (7) of Section 20 of the Ordinance directs that

upon the taxable income of every company, tax shall be charged at the rates specified therein. Section 43(1) entitles every resident company to

deduct from the amount of any dividend which becomes payable during a year of assessment to any shareholder, tax at twice ""the unit rate"" in

force for the year preceding the year of assessment in which such dividend becomes payable.

Under the second proviso to this sub-section the Commissioner is empowered to give notice in writing to the company that in respect of the

dividends payable to a particular shareholder, tax at a greater rate than twice the unit rate shall be deducted. On receipt of such notice the

company is bound to deduct tax from all dividends paid to the particular shareholder at the rate mentioned in the notice. The proviso continues,

the tax so deductable in excess of tax at twice the unit rate shall be a debt due from the company to the Government of Ceylon and shall be

recoverable forthwhile as such or may be assessed and charged upon the company in addition to any other tax otherwise payable by it.

The position therefore is this. On its income a company resident in Ceylon pays Income Tax just like any individual. But, it is entitled to de-duct

from the dividends payable to a shareholder tax at twice the unit rate. The company is entitl- ed to keep for itself the tax it has to deducted and it is

not bound to pay it over to Government. It is only tax which it deducts at a rate, higher than twice the unit rate in pursuance of a notice issued by

the Commissioner that it is bound to pay over to Government.

Sub-section (2) of Section 43 requires every person who issues a warrant or cheque or order for payment of the money relating to a dividend,

to annex thereto a statement in writing showing-

(a) the gross amount which after deduction of the tax appropriate thereto corresponds to the net amount actually paid;

(b) the rate and the amount of tax appropriate to such gross amount, and

(c) the net amount actually paid."" Sub-section (3) reads:

Where the assessable income of a person includes a dividend from a resident company paid in the form of money or of an order to pay money he

shall be entitled on production of a statement relating to such dividend made in accordance with Sub-section (2), to a set-off against the lax

payable by him of the amount of tax shown on such statement.

Section 49 of the Ordinance provides for what we call the grossing up of the income from dividends.

It is thus seen that the amount of Rs. 8024 which the company deducted from the dividend warrant of Ramaswami Naidu and the amount of Rs.

7375 which it deducted from the dividend warrant of Govindaswami Naidu were moneys which was entitled to retain for itself and which it was

not bound to pay over to the Ceylon Government.

These provisions of the Ceylon Income Tax Ordinance merely incorporate the appropriate provisions of the English law on the subject.

An exposition of the history of this part of the law is to be found on pages 338 to 360 of the case reported in Neumann v- Commissioners of

Inland Revenue (1933) 18 Tax Cas 332:

The relative provisions of a company and the shareholders of the company in relation to Income Tax under the Income Tax Acts have always

been recognised as special in character. It was never, 1 think, doubted that, under the Act of 1842, the profits of a business carried on by a

company were taxable against the company under Schedule D, and were not taxable again, after distribution, in the hands of the shareholder under

Schedule D or any other schedule. At the same time, it was permissible to the company, u/s 54 of the Act of 1842, to deduct from the dividend the

proportionate part of the tax paid to the tax collector, and the shareholders entitled to exemption from or abatement of Income Tax could, upon

the footing of the deduction obtain the necessary return of tax. I cannot but think that the position under the Act of 1842 upon its proper

construction is correctly described in the following passage from the speech of Lord Phillimore in Bradbury v. English Serving Cotton Co:, Ltd.,

1823 AC 744: ''A joint stock company is under the Income Tax Act, 1842, treated as a person and is directed to make a return of its profits or

gains according to schedule D upon a conventional figure, arrived at by taking an average of the three preceding years, and is liable to be assessed

and taxed thereupon. If the principle of its being a distinct person, distinct from its shareholders or the Aggregate of its shareholders, had been

carried to a logical conclusion, there would have been no reason why each shareholder should not, in his turn, have to return as part of his profits

or gains under Schedule D, the money received by him in dividends. Their taxation would seem to be logical but it would be destructive of joint

stock company enterprise, so the Act of 1842 has, apparently, pro-ceeded on the idea that for revenue purposes a joint stock company should be

treated as a large partnership, so that the payment of Income Tax by a company would discharge the quasi-partners. The reason for their

discharge may be the avoidance of double taxation, or to speak accurately, the avoidance of increased taxation. But the law is not founded upon

the introduction of some equitable principle as modifying the statute; it is founded upon the provisions of the statute itself; and the statute carries the

analogy of a partnership further for it contemplates a company declaring a dividend, on the gross gains, and then on the face of the dividend

warrant making a proportionate deduction in respect of the duty, so tbat the shareholder whose total income is so small that he is exempt from

income tax or pays at a lower rate can get the Income Tax which has been deducted on the dividend warrant returned to him.

In practice, the matter did not work out quite so simply. It has to be remembered that the amount distributable in dividend in any year might, in

view of the assessment of profits or gains under Schedule D being upon the basis of the average of the three preceding years, as it then was, be

much more or much less than the amount of the assessment for that year, so that if this proportionate deduction was reated as meaning the rateable

proportion of the tax paid by the company in respect of the year of distribution, it might much exceed or be much less than the amount which

would be deducted from the dividend if the current rate of tax in respect of the gross dividend had been deducted. At any rate, a practice seems to

have grown up of companies deducting from dividends tax appropriate to the amount of the dividend at the current rate of tax, quite irrespective of

the amount of tax paid by the company to the Revenue, and of the shareholders claiming exemption or abatement being treated by the Revenue as

having paid tax to the extent of that deduction. As the company making the deduction lay under no obligation to pay to the Revenue anything more

than the tax based upon its own assessment, the result was that the tax returned to those claiming exemption or abatement could rarely, if ever,

have had any exact relation to the amount of tax received by the Revenue from the recipient of returned tax.

Section 43 of the Ceylon Ordinance merely, incorporates the provisions of rule 20 of the General Rules applicable to Schedules A, B, C, D

and E, of the English Act.

The question we have to decide is whether the two sums of Rs. 8,024 and Rs. 7.375 which the company deducted in the circumstances

already mentioned, are liable to be included for purposes of Indian Income Tax in the income of the as-sessees.

u/s 4 of the Indian Income Tax Act, the total income of an individual who is resident in the taxable territories includes,

all income profits and gains (a) which are actually received or deemed to be received in the taxable territories (b) which accrue or arise or deemed

to accrue or arise in the taxable territories, and, (c) which accrue or arise without the taxable territories.

The other provisions of the section are not here material. It is nobody''s case that these two amounts were at any time received either by

Rama-swami Naidu or by Govindaswami Naidu. Nor do we think that it can be properly said that these amounts ''accrued or arose to'' these

individuals. There is a clear explanation of the subject on pages 49 to 51 (of ITR): (at pp. 481-482 of AIR) in E.D. Sassoon and Company Ltd.

Vs. The Commissioner of Income Tax, Bombay City, . The Privy Council in AIR 1932 138 (Privy Council) attempted a definition of the term

income"" in the words following :--

Income, their Lordships think, in the Indian Income Tax Act, connotes a periodical monetary return ''coming in'' with some sort of regularity or

expected regularity from definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be one

whose object is the production of a definite return, excluding anything in the nature of a mere windfall."" Mukerji J. has defined these terms in

Rogers Pratt Shellac Company Vs. Secretary of State, .

Now what is income? The term is nowhere defined in the Act ..... In the absence of a statutory definition we must take its ordinary dictionary

meaning--''that which comes in as the periodical produce of one''s work, business, lands, or investments (considered in reference to its amount and

commonly expressed in terms of mouey); annual or periodical receipts accruing to a person or corporation (Oxford Dictionary). The word clearly

implies the idea of receipt, actual or constructive. The policy of the Act is to make the amount taxable when it is paid or received either actually or

constructively, ''Accrues'' ''arises'' and ''is received'' are three distinct terms. So far as receiving of income is concerned, there can be no difficulty; it

conveys a clear and definite meaning, and I think of no expression which makes its meaning plainer, than the word ''receiving'' itself. The words

''accrue'' and ''arise'' also are not defined in the Act. The ordinary dictionary meanings of these words have got to be taken as the meanings

attaching to them. ''Accruing'' is synonymous with ''arising'' in the sense of springing as a natural growth or result. That three expressions ''accrues'',

''arises'' and ''is received'' having been used in the section, strictly speaking, ''accrues'' should not he taken as synonymous with ''arises'' but in the

distinct sense of growing up by way of addition or increase or as an accession or advantage; while the word ''arises'' means comes into existence

or notice or presents itself. The former connotes the idea of a growth or accumulation and the latter of the growth or accumulation with a tangible

shape so as to be receivable. It is difficult to say that this distinction has been throughout maintained in the Act and perhaps the two words seem to

denote the same idea or ideas very similar, and the difference only lies in this that one is more appropriate than the other when applied to particular

cases. It is clear, however, as pointed out by Fry LJ in Colquohoun v. Brooks, (1888) 21 QBD 52 (this part of the decision not having been

affected by the reversal of the decision by the House of Lords) that both the words are used in contradistinction to the word ''receive'' and indicate

a right to receive. They represent a state anterior to the point of time when the income becomes receivable and connote a character of the income

which is more or less inchoate.

One other matter need be referred to in connection with the section. What is sought to be taxed must ho income and it cannot be taxed unless it

has arrived at a stage when it can be called ''income.''

14-15. The observations of Lord Justice Fry quoted above by Mukerji J. were made in (1888) 21 QBD 52, while construing the provisions of 16

and 17 Vict Ch. 34, Section 2. Schedule ""D"". The words to be construed there were ''profits or gains, arising or accruing'' and it was observed by

Lord Justice Fry at page 59;

In the first place, I would observe that the tax is in respect of ''profits or gains arising or accruing.'' I cannot read those words as meaning

''received by''. If the enactment were limited to profits and gains ''received by'' the person to be charged, that limitation would apply as much to all

Her Majesty''s subjects as to foreigners residing in this country. The result would be that no in-come-tax would be payable upon profits which

accrued hut which were not actually received, although profits might have been earned in the kingdom and might have accrued in the kingdom. I

think, therefore, that the words ''arising or accruing'' arc general words descriptive of a right to receive profits.

To the same effect are the observations of Satyanarayana Rao J. in Commissioner of Income Tax Vs. Anamallais Timber Trust Ltd., , and

Mukherjce J. in Commissioner of Income Tax, Bombay Vs. Ahmedbhai Umarbhai and Co., Bombay, , where this passage from the judgment of

Mukherji J. in Rogers Pratt Shellac Company Vs. Secretary of State, , is approved and adopted. It is clear, therefore, that income may accrue to

an assessee without the actual receipt of the same. If the assessee acquires a right to receive the income, the income can be said to have accrued to

him though it may be received later on its being ascertained. The basic conception is that he must have acquired a right to receive the income.

There must be a debt owed to him by somebody. There must be as is otherwise expressed debitum in praesenti, solvendum in futuro; see W. S.

Try Ltd. v. Johnson (Inspector of Taxes) 1946-1 All ER 532, and Webb v. Stenton, (1883) 11 QBD 518, Unless and until there is created in

favour of the assessee a debt due by somebody it cannot be said that he has acquired a right to receive the income or that income has accrued to

him.

The two amounts we are concerned with were always the property of tire company. At no point of time did the title to these amounts vest in

the assessees. At no point of time could the assessees have said that it was their money. Regard being had therefore to the meaning of the words

''income'' and ''accrue'' used in the Indian Income Tax Act these amounts are not, in our opinion, liable to be included in the income of the

assessees for purposes of the tax.

We find that a view similar to ours was taken in Jolly v. Federal Commissioner of Taxation, 50 Com WLR 131 which is a case decided by the

High Court of Australia under provisions substantially the same. We extract the relevant passages:

A governing principle of British Income Tax law is taxation at the source, and, in accordance with this principle, the profits and gains of a body of

persons, an expression which includes a joint stock company, are brought into charge before they are divided, and the body of persons paying a

dividend is entitled to deduct the tax appropriate thereto (rule 20 of the All Schedules, Rules, Income Tax Act. 1918). When a company declares

a tax free dividend, it is regarded, at any rate for many purposes, as dividing profits sufficient in amount to pay a gross dividend which, after

deduction of tax, will leave the net amount at which the dividend is expressly declared. .... The system, however, of taxation at the source involves

a treatment of corporate profits which is not compatible with any general inclusion of dividends in the shareholder''s own assessment to Income

Tax. The profits and gains are assessed in the hands of the company prior to distribution. They are taxed collectively. Upon distribution the

company is authorised, but not required, to deduct from the dividend the tax which would be payable upon the dividend. The company does not

account to the Crown for the amount deducted; for the profits distributed have already borne tax in its hands. But, for the purposes of reliefs

allowed to tax payers, the shareholder is entitled to treat himself, as having paid by deduction the amount which the company has withheld in

paying his dividend; and in assessing his liability to super-tax or surtax, which is levied on his total income from all sources, the amount so withheld

as well as the dividend must be included .....The question whether the shareholder obtains immunity from taxation by direct assessment if, and only

if he suffers a deduction in respect of tax from the dividend, appears to me to be of some importance in relation to the question whether the actual

or imputed deduction made should be considered dividend or profit credited or paid to the shareholder within the meaning of Section 14(b) of the

Commonwealth Income Tax Assessment Act, 1915-1921. Unless this be so. I think the remaining incidents of the relation of the shareholder to the

gross amount, actual or notional, of the dividend are against the view that the excess over the amount he receives is credited or paid to him. That

excess the company is by law entitled to withhold whe-ther it is included within or excluded from the amount of the dividend expressly declared.

When the company retains such a sum, it forms part of its general funds and is applicable accordingly. The fact that it specifies in its declaration of

dividend a larger sum or rate than it in fact pays, does not seem of importance, In point of law it incurs no liability to the shareholder by doing so

for any amount except the net sum after the deduction. Whether it be correct or not, that before Section 7 of the Finance Act, 1931, the company

was authorised to make a deduction from dividends out of profits on which the company paid no tax (see per Romer L. J. in Neumann v. Commr.

of Inland Revenue, 1933 1 KB 728), it is clear that deduction of tax did not operate by way of set-off or otherwise to discharge any liability for

any sum paid by the company for tax. There is no appropriation to or for the use of the shareholder; no tiling done by the company on his account

or for his use. If it be true the shareholder''s immunity from direct assessment depends upon his suffering a deduction from dividend, all that can be

said is that, by making the deduction, the company ipso facto discharges or absolves the shareholder from a direct liability to the Crown for tax in

respect of the dividend. I do not think that in the peculiar situation in which the shareholder stands this would he enough to constitute a credit to him

of the profits within Section 14(b) as construed in Webb''s case, 1922 30 CLR 450 and Jame''s case, 1924 34 CLR 404. The destruction or

prevention of the shareholder''s liability to tax would be a consequence ensuing from the deduction as a result of an express provision of positive

law, a statutory phenomenon, and not a discharge by payment or appropriation of money for the purpose. The money would not be credited to the

tax payer and applied by the company in discharge of his liabilities.

The learned Judge finally expressed this conclusion:

In my opinion no more than the net amount paid to the tax payer by the company in respect of dividends on preference or on ordinary stock was

credited or paid to him. He is not liable to-the inclusion in his assessment of any greater amount ot dividend.

The treatment of the matter by Dixon J. was so comprehensive that on appeal from his decision the learned judges contented themselves with

this statement:

In this case the appeal will be dismissed.

To the same effect is the decision in Home Crown Sugar Ltd. In re 1938 1 Ch 219 Simonds J. observed.

Apart, however, from this consideration it appears to me reasonably clear that the amount of dividend received by a shareholder within the

meaning of this clause is that sum which he actually receives after the company has exercised the right to deduct the appropriate amount of tax,

which is given to it by Rule 20 of the All Schedules Rules of the Income Tax Act, 1918.....But it does not, in my view, follow that the shareholder

is, for the purpose of such an article as this, to be regarded as receiving what he does not in fact receive. Such a contention would be weightier if

the shareholder, being entitled to receive the whole dividend, directed the company to pay the appropriate part of it as Income Tax on his behalf.

Rut that is not the position. Indeed, so far is it from being the position that the company itself decides whether it will or will not deduct tax from

dividend, and will be guided in the amount of dividend which it declares by its decision to deduct or not to deduct tax.

Similar views were expressed in Cull v. Inland Revenue Commissioners. [1940] 8 ITR Sup 1. At page 4 Lord Atkin observed :

It is now clearly established that in the case of a limited company the company itself is charge-able to tax on its profits, and that it pays tax in

discharge of its own liability and not as agent of its shareholders. The latter are not chargeable with Income Tax on dividends, and they are not

assessed in respect of them.....The Crown contended that this Sub-section (Section 7(2) of the Finance Act, 1931) on its true construction applied

to all cases where a deduction was authorised to be made and was not confined to those in which a deduction had actually been made. In their

submission it, therefore, for the purposes of income, imputed to the person receiving a payment in cases where no deduction had in fact been made

the receipt of a hypothetical sum calculated as though deduction had been made; what is now known in, Income Tax slang as ''grossing up''.

Whatever might have been said for this construction before 1934, it is impossible now to accept it, for by the decision of this House in 1933 103

LJ KB 210, it was expressly held to be wrong.

The same view was taken by the Calcutta High Court in THE ANGUS CO. LTD. CALCUTTA Vs. COMMISSIONER OF INCOME

TAX, WEST BENGAL., , where the learned Chief Justice observed:

To my mind, the one fact which seems to remove all doubts as to the true character of the payment of the tax of Rs. 70,313 is that the company

did not have to pav it and did not in fact pay it, because it declared the dividend, but would have to pay it as a part of the charge on its own profits,

in any event, whether it declared any dividend or not. The payment was therefore not on account of the declaration of the dividend and it was not

by reason of the declaration that the funds of the company were depleted to the extent of Rs. 70,313.

Section 18 of the Indian Income Tax Act requires every person responsible for paying salaries to deduct at the time of payment, Income Tax

and supertax at certain rates to be ascertained. The money so deducted never comes into the hands of the employee. Nevertheless, it is treated for

purposes of tax as part of the salary. The amount deducted by the company from the gross dividend of the assessees must, argued Mr. Rama Rao

Sahib, be regarded in the same way.

We are unable to agree that the positions are similar. The money which the persons charged with disbursing salaries is required to deduct on

account of Income Tax and super-tax is really the money of the assessee. But, in the cese of the present assessees Ramaswami Naidu and

Govindaswami Naidu, the amounts which Agravas Estates Ltd., retained in their hands were always the money of AgraVes Estates Ltd. and at no

time become the money either of Ramaswami Naidu or Govindaswami Naidu.

Another point of difference is this: the person disbursing a salary is under a duty to deduct the tax, but u/s 43 of the Income Tax Ordinance the

company was under no such obligation. It had a right to deduct that it was not under an obligation to do so.

Thirdly, a person deducting Income Tax and super-tax from any salary is bound to pay the money so deducted to Government. But, Agraves

Estates Ltd., was entitled to keep the moneys it deducted. It is true that the company was bound to show the amount it deducted in the dividend

warrants which it issued, but that is only for the purpose of explaining how the final figure was ob- tained. The obligation of the company to exhibit

in the dividend warrants the arithmetic of the processes involved does not have the effect of making the moneys it did not pay, the moneys of

Rama-swami Naidu or Govindaswami Naidu.

Be it remembered that when a company pays Income Tax on its profits it does not do so as an agent of the shareholder. See Article 24 in Vol.

III of Simon''s Income Tax, 2nd Edn.:

Taxation of companies etc.:-- A company is charged to tax on the full amount of its profits or gains, before the payment of any dividend in respect

of any share, right or title thereto, computed in accordance with the provisions of the Income Tax Acts. A company pays Income Tax on its profits

as being itself a taxpayer, not as agent for its share-holders; if no dividend is declared by the company, the shareholders are not concerned with the

payment of tax.

In support of his argument that the amounts Rs. 8024 and Rs. 7375 retained by Agravas Estates Ltd., must be deemed to be the income of the

assessees Ramaswami Naidu and Govindaswami Naidu, Mr. Rama Rao Sahib referred to the decision in Joseph Kay, K.B.E. Vs. Commissioner

of Income Tax, Bombay City, Bombay, . The relevant facts there were as follows: Sir Joseph Kay, the assessee, was entitled to receive from three

insurance companies in the United Kingdom annuity amounting to �500 a year.

The insurance companies deducted Income Tax under the English Income Tax Act, 1918, at the standard rate amounting to �275. The assessee

was paid only �225. The assessee contended that only the sum of �225 which he actually received should be included in his total income. The

department thought that the whole of the �500 should be included even though he had not received �275 and, the question was whether the

sum of �500 or the sum of �225 alone should be included in the assessee''s total income. The court held that the whole of the amount of

�500 ought to be included in the assassee''s total income.

It seems to us that this decision which relates to an annuity cannot be applied to the case of dividends. An annuity, if it resembles anything at all

resembles a salary or a pension and, the amount deducted from an annuity on account of tax, must be treated in the same way as an amount

deducted from a salary or pension on account of Income Tax. We do not consider that the decision cited by Mr. Rama Rao Sahib is applicable.

In the result, we hold that the amounts of Rs. 8024 and Rs. 7375 cannot be included in the taxable income of the assessees. These amounts

were never received by the assessees, at no time did the amount accrue or arise to the assessees; at no time actually or nationally were the money

the income of the assessees in any sense of that word.

The question is answered in favour of the assessees. Respondent will pay the cost. Counsel''s fee Rs. 250.