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Income‑tax Reference No. 18 of 1959, decided on 20th June 1962.
Distribution order‑Excep tion‑Smallness of profits Amounts set apart towards gratuity and bonus‑Whether should be excluded‑Income‑tax Act, 1922, S. 23‑A.
The assessable income of the assessee (a private company to which section 23‑A of the Income‑tax Act, 1922, applied) for the calendar year 1947 relevant to the assessment year 1948‑49 was computed at Rs. 7,05,821. The tax payable thereon amounted to Rs. 3,08,797 and the balance was Rs. 3,97,024. The dividend declared by the company at its annual general meeting held in September 1948 amounted to Rs. 1,10,000. As this amount was less than 60% of the balance the Income‑tax Officer made a dis tribution order under section 23‑A. The assessee contended that in ascertaining the distributable profits the sum of Rs. 1,00,200 set apart for gratuity calculated up to the end of 1947 and the sum of Rs. 1,04,000 to meet its liability for bonus for. 1947 ought to be excluded in order to see whether having regard to the smallness profits an order under section 23‑A should be made or not. The sum of Rs. 1,00,200 set apart for gratuity was in accordance with the award which came to be made in the follow ing circumstances and the sum of Rs. 1,04,000 towards bonus, was calculated at the rate of two months' salary. The Union to which the assessee's employees belonged had made demands in October, 1946, for gratuity and for bonus for the year 1946 and these demands the assessee did not concede. The dispute that arose was then referred to the industrial court in November 1947, for adjudication and the industrial court made its award in March 1918, granting gratuity to all monthly paid employees who had completed 10 years service at the rate of half a month's salary for each year of service and bonus at 1 months salary for the year 1946. The. Appellate Tribunal rejected the conten tion of the assessee. On a reference:
Held, (i) that liability to pay gratuity had been incurred by the assessee as a result of the award so far as its workers who had completed 10 years of their service were concerned and when liability in this respect has accrued, it set apart the sum of Rs. 1,00,200 to meet its liability in this respect. It could not, therefore, be said that the assessee was making a provision or building up a reserve fund to meet its future liability.
(ii) That as the industrial court had awarded bonus for the year 1946, the liability to pay bonus at a similar rate for 1947 was very imminent and even certain as the assessee had made large profits during 1947 also. A sum set apart to meet such imminent and. certain liability was an allowable deduction in determining the distributable profits in a commercial sense.
(iii) That, therefore, the Tribunal was not justified in not taking into account at all the amounts set apart by the assessee in determining the distributable profits. But what sum should be actually allowed to be set apart towards the liability to pay gratuity and the liability to pay bonus was a matter for determina tion upon the evidence before the Tribunal.
Commissioner of Income‑tax v. Bipinchandra Maganlal & Co. (1961) 41 I T R 290 (S C) ref.
In compliance with the requisistion of the High Court under section 66(2) of the Income‑tax Act in the case of Messrs Greaves Cotton & Crompton Parkinson Ltd., Bombay v. Commissioner of Income‑tax, Bombay City I, Bombay (I. T. A. No. 4 of 1957), we state the case and refer it to the High Court of Judicature at Bombay.
2. The High Court has directed the Tribunal to refer the following question:
"Whether the sums of Rs. 1,00,200 (Rupees one lakh and two hundred) and Rs. 1,04,000 (Rupees one lakh and four thousand) being provisions for retiring gratuities and bonus to the employees, should be excluded while determining the applicants' actual accounting profits for the purpose of deciding whether having regard to the smallness of the said profits an order under section 23‑A of the Indian Income‑tax Act, 1922, ought to be made or not "
3. The assessee (hereinafter referred to as the company) is a private limited company. The assessment year is 1948‑49 and the previous year is the calendar year 1947. The law applic able is the law that was in force during the assessment year 1948-49. According to this the assessee was a company to which the provisions of section 23‑A would apply. There is no dispute about this.
4. For the assessment year 1948‑49, the Income‑tax Officer computed the assessable income of the company at Rs. 7,05,821. The tax payable thereon amounted to Rs. 3008,797. Sixty percent. of the balance, i.e., Rs. 3,97,024, amounted to Rs. 2,38,214. However the dividend actually declared by the company at its annual general meeting held on August 2, 1948, amounted to Rs. 1,10,000 only. As this was less than 60 percent. of the distributable profits, the Income‑tax Officer, after duly obtaining the sanction of the Inspecting Assistant Commissioner of Income‑ tax as required by law, passed an order under section 23‑A(1) that the undistributed portion of the assessable income of the company shall be deemed to have been distributed as dividends amongst the shareholders as at the date of the general meeting aforesaid. There is no dispute about any of the figures mentioned above. In computing the assessable income the Income‑tax Officer had added back various amounts as under:
|
| Rs. |
| (a) Gratuity paid to the widow of an employee | 10,000 |
| (b) Charity and gifts | 1,137 |
| (c) Secret commission | 24,974 |
| (d) Reserve for liability tin account of employees retiring gratuity | 1,00,200 |
| (e) Reserves for bonus to employees | 1,04,000 |
There is no dispute about the add‑backs either. However, it was contended before the Income‑tax Officer that, for the purpose of considering the applicability of section 23‑A, all these amounts should be taken to have reduced the accounting profits of the company from which the dividends could be distributed. The contention was accepted by the Income‑tax Officer only in regard to items at (b) and (c) above. He accordingly passed the order as aforesaid in respect of the undistributed profits computed as under:
|
| Rs. | Rs. |
| Income assessed | 7,05,821 |
|
| Less: |
|
|
| Tax | 3,08,797 |
|
| Dividends declared | 1,10,000 |
|
| Charity and gifts | 1,137 |
|
| Secret commission | 24,974 | 4,44,908 |
|
|
| 2,60,913 |
5. In appeal the Appellate Assistant Commissioner upheld the order of the Income‑tax Officer and, moreover, he held that the two items excluded by the Income‑tax Officer equally became the subject‑matter of the order under section 23‑A and he accord ingly, recomputed the undistributed profits at Rs. 2,87,024.
6. The matter came up before the Tribunal in due course and the contention before the Tribunal only was that items at (d) and (e) above should also be excluded from consideration. This contention was based on the argument that although these amounts were correctly added back in computing the assessable income of the company they did not form part of the accounting profits from which dividend could be distributed. The Tribunal negatived the assessee's claim observing that the above two sums were only provisions made and were in the nature of reserves for future, expenditure, that the actual expenditure out of these reserves was always allowed as a deduction in the year in which the expenditure was incurred‑there was no dispute about that and there was no provision for future expenditure being allowed as admissible claim under any of the sections of the Indian Income‑tax Act. It, therefore, held that these two amounts could not be excluded in computing the undistributed profits of the company.
7. The Tribunal also found that even on the company's own argument the minimum dividend that should have been declared by the company to fall clear of the provisions of section 23‑A should have been 60 percent. of Rs. 1,92,824 (Rs. 3,97,724 minus Rs. 1,04,000 plus Rs. 1,00,200) or Rs. 1,15,692. The actual dividend declared, however, was only Rs. 1,10,000. The company thus in any case attracted the provisions of section 23‑A.
8. Shri Kolah, appearing for the assessee, wanted the entire paragraph 7 of the statement to be deleted on the ground that in the event of Rs. 1,10,000 being considered as less than sixty percent. of the distributable profits but being not less then fifty -five percent. of the distributable profits, a notice as required by the proviso to section 23(1) must have been given by the Income‑tax Officer. The Departmental Representative objects to the deletion. Since it was nobody's case that the proviso applied the question of giving any such notice did not arise. We think the factual statement made therefore in paragraph 7 being correct, there is no need to delete the paragraph.
Parties agree that all the facts necessary for drawing up the statement of the case have been correctly stated.
10. The question as directed and set out in paragraph 2 is accordingly referred:
"Whether the sums of Rs. 1,00,200 (Rupees one lakh and two hundred) and Rs. 1,04,000 (Rupees one lakh and four thousand) being provisions for retiring gratuities and bonus to the employees, should be excluded while determining the applicants' actual accounting profits for the purpose of deciding whether having regard to the smallness of the said profits an order under section 23‑A of the Indian Income‑tax Act, 1922, ought to be made or not "
SUPPLEMENTARY STATEMENT OF CASE
In obedience to their Lordships' directions, we submit the supplementary statement of the case called for under section 66(4) in the above case agreed to by both the parties.
2. In their order their Lordships have been pleased to observe as follows:
" . . the assessee claimed that an amount of Rs. 1,00,200 and Rs. 1,04,000 should have been deducted in determining the amount of distributable profits . . . . . we, however, find that the statement of the case submitted to this court is silent as to the nature, character and the circumstances under which the assessee company has claimed deduction of these two amounts. Unless and until the aforesaid things relating to these two items are known, we feel, it will not be, possible for us to answer the question which we have been called upon to answer. It is necessary to have a clear finding whether the sum of Rs. 1,04,000, of which deduction is claimed, represents the liability of the assessee company in respect of the payment of bonus to its workers for the calendar year 1947 in accordance with the award. It is also necessary to know whether the 'sum of Rs. 1,00,200 represents the amount of gratuity calculated up to the end of the calendar year 1947 in accordance with the scale mentioned in the award."
3. In its return dated April 20, 1949, for the calendar year 1947, the previous year for assessment year 1948‑49, the assessee added back the following amounts to the profits according to its published profit and loss account, in its computation for determination of its total income:
| Reserve for employees' retiring gratuity | Rs. 1,00,200 |
| " bonus to employees | Rs. 1,04,000 |
4. In the proceedings under section 23‑A that ensued, the assessee contended that, inter alia, the above amounts should be treated as outgoings which were not available for distribution. These proceedings terminated by the order of the Income‑tax Officer dated March 17, 1952.
5. There was an industrial dispute between the assessee and its employees which was referred to tire Industrial Tribunal on February 11, 1947. The relevant portions of its award in this dispute dated March 18, 1948, are to be found in Annexure "A" annexed hereunto and forms part of the case. Under this award gratuity became payable to all the employees retiring after ten years of service on the scale as prescribed therein.
6. Details of all the employees who had completed ten years of service in 1947 and the gratuity payable to them because of their service during that year, in accordance with the above award are to be found in the statement annexed hereunto as Annexure "B" and forms part of the case. In this statement is also to be found, in parallel columns, the sum actually claimed for each of them totalling Rs. 1,00,200.
7. The assessee has paid bonus to its workers from time to time. There has been in each year estimated provision in the first instance, any excess or deficiency being made good by later adjustments in the year of actual payment. The bonus, however, was allowed as deduction on the basis of the actual payments only in those years. Under this arrangement Rs. 89,348 has been paid in 1947 and allowed as a deduction.
8. In addition' to the above, the assessee claimed in the corresponding section 23‑A proceedings the aforesaid sum of Rs 1,04,000 being bonus payable to its workers for their service during 1947. Details of this claim, worker‑war, are to be found in Annexure "C" annexed hereunto and forms part of the case. The whole of this bonus has been actually paid and allowed as a deduction in the subsequent year 1948 relevant to the assessment year 1949‑50.
N. A. Palkhivala with F. N. Kakkda for the Assessee.
G. N. Joshi with R. J. Joshi for the Commissioner.
On a requisition made by this court under section 66(2) of the Income‑tax Act (hereinafter referred to as the Act) the Income‑tax Appellate Tribunal drew up a statement ‑ of case and referred to this court the following question of law:
"Whether, the sum of Rs.1,00,200 (Rupees one lakh and two hundred) and Rs. 1,04,000 (Rupees one lakh and four thousand) being provisions for retiring gratuities and bonus to the employees should be excluded while determining the applicants' actual accounting profits for the purpose of deciding whether having regard to the smallness of the said profits an order under section 23‑A of the Indian Income‑tax Act, 1922, ought to be made or not "
It has been agreed between the parties that to bring out the real controversy the question should be reframed in the following manner:
"Whether, on the facts and in the circumstances of the case, the Tribunal was justified in disallowing the sums of Rs. 1,00,200 and Rs. 1,04,000 in determining the assessee's actual accounting profits for the purpose of deciding whether having regard to the smallness of the said profits an order under section 23‑A of the Indian Income‑tax Act, 1922, ought to be made or not, on the ground that they are in the nature of reserves to meet future expenditure "
Facts giving rise to this question may briefly be stated:
We are concerned with the assessment year 1948‑49, the rele vant accounting year being the calendar year 1947. The assessee is a private limited company coming under the purview of section 23‑A of the Act. The business of the assessee company was engineering and manufacturing machinery. For the said assessment year the Income‑tax Officer computed its assessable income at Rs. 7,05,821. The tax payable thereon amounted to Rs. 3,08,797, leaving a balance of Rs. 3,97,024. Sixty percent. thereof amounted to Rs. 2,38,214. The dividend declared by the assessee company at its annual general meeting held on 2nd September 1948, amounted to Rs. 1,10,000. As this amount was less than 60 percent. of the said sum of Rs.2,38,214, the Income‑tax Officer, after duly obtaining sanction of the Inspecting Assistant Commissioner of Income‑tax, passed an order under section 23‑A (1) of the Act, that the undistri buted portion of the assessable income of the assessee com pany .shall be deemed to have been distributed as dividend amongst the share‑holders on the aforesaid date of the general meeting. The assessee challenged this order on various grounds. We are, however, here concerned only with the two items, which, according to the assessee, should have been excluded in determining its distributable profits. It appears that the employees of the assessee‑company and three other allied companies had formed a Union by name Greaves Cotton and Allied Companies Employees' Union. In October, 1946, the Union made various demands including a demand for gratuity and payment of bonus for the year 1946. These demands were not conceded by the company. Consequently, there was a threat given by the employees to resort to strike. The dispute, however, was referred to the Industrial Court, Bombay, for adjudication on 11th November 1947. As regards the gratuity the demand was that an employee should be entitled to get gratuity at the rate of half a month's salary (drawn by him at the time of payment of gratuity) for each year of service on completion of 10 years' service or in the case of disabi lity or death, should it occur earlier. As regards the bonus, the demand was that at least two months' salary as bonus should be paid to all the employees every year.
As already stated these demands were not conceded, by the assessee and other companies. The industrial court made its award on 18th March 1948. The award granted gratuity to all the monthly‑paid workers according to the Bank's Award with the alteration that it should be paid at the rate of half a month's salary for each year of service as demanded. The award further directed the assessee‑company to give bonus equivalent to 11 months' salary for the year 1946. From its profits of the year 1947, the assessee has set apart a sum of Rs. 1,00,200, which, according to the assessee, represents the amount of gratuity calculated up to the end of the calendar year 1947, in accordance with the scale mentioned in the award. It has further set apart a sum of Rs. 1,04,000 to meet its alleged liability of paying bonus, to its worker's for the year 1947. Before the Tribunal the assessee contended that these two sums should be excluded in determining the asses see's distributable profits for the purpose of deciding whether, having regard to the smallness of the said profits, an order under section 23‑A of the Act should be made or not. The argument advanced was that, although these two sums were correctly added back in computing the assessable income of the asses see company, they did not form part of the accounting profits in a commercial sense from which dividend' could be distributed. The Tribunal rejected this contention of the assessee and the reasons given by the Tribunal are:
"The provisions made are in the nature of reserves and it is not disputed that they would be allowed as deduc tion as and when the sums are expended, i.e., paid as gratuity to retiring employees or bonus to the employees. That had been the practice in the past and it is not also disputed that in the subsequent assessments the departmental officers were allowing deduction of actual payment irrespec tive of the provisions made in prior years. Therefore, the pro visions during the year under dispute are nothing but reserves. The section also is perfectly clear. It does not allow for future payments. It reads : ...the Income‑tax Officer shall, unless he is satisfied ...that having regard to losses incurred by the company in earlier years or to the smallness of the profits made in the previous year, the payment of a divi dend or a larger dividend than that declared would be unreasonable ' There is do provision for future expenditure at all. The Appellate Assistant Commissioner, in our opinion, has given the finding in clear terms. We do not see any substance in the appeal. The result is that the appeal is dismissed."
On a requisition made by this Court under section 66(2) of the Act the Tribunal has drawn up a statement of case and referred the question of law to this Court, which we have now reframed as stated above.
The short question that arises is whether the Tribunal was right in refusing to take into account these two sums in considering the question whether, having regard to the smallness of the profits of the company, an order under section 23‑A of the Act should have been made or not on the sole ground that the sums set apart are in the nature of reserves to meet future expenditure. We find it difficult to accept the contention of the department that the said sums set apart by the assessee can be termed as reserves built up to meet future expenditure. We are not here concerned with the determination of the taxable income of the assessee company or whether these two sums should be allowed as deductions in determining the taxable income of the assessee company. But, on the other hand; we are here concerned with determining the question about the reasonableness or other wise of the company in declaring the dividends it has declared, having regard to its business profits. In this connection the following observations of their Lordships of the Supreme Court in Commissioner of Income‑tax v. Bipinchandra Maganlal & Co. Ltd. ((1961) 41 I T R 290,296) afford useful guidance:
"In considering whether a large distribution of dividend by a company would be unreasonable, for the purpose of deciding whether a distribution order should be made under section 23‑A of the Income‑tax Act in respect of the com pany, the source from which the dividend is to be distributed and not the assessable income has to be taken into account. The Legislature has not provided in section 23‑A that in considering whether an order directing that the undistributed profits shall be deemed to be distributed, the smallness of the assessable income shall be taken into account. The test whether it would be unreasonable to distribute a large dividend has to be adjudged in the light of the profit of the year in question. Even though the assessable income of a company may be large, the commercial profits may be so small that compelling distribution of the difference between the balance of the assessable income reduced by the taxes payable and the amount distributed as dividend would require the company, to fall back either upon its reserves or upon its capital which in law it cannot do ..The Legislature has deliberately used the expression smallness of profit' and not smallness of assessable income' and there is nothing in the con text in which the expression smallness of profit' occurs which justifies the equation of the expression profit' with assessable income'. Smallness of the profit in section 23‑A has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional."
In the light of these observations, the facts of the present case will have to be appreciated. Recapitulating them, the, dividends were declared on 2nd September 1948. Prior to that date an award has been made on 18th March 1948, and that award provided that gratuity would be payable to those workers who, have completed ten years of service and who have to leave their jobs on account of disability or death at the scale stated therein. Liability in the matter of payment of gratuity had thus been incurred by the assessee company as a result of the award so far as its workers who had completed ten years of their service. The assessee company had, in these circumstances, set apart the sum of Rs. 1,00,200 to meet its liability in this respect. The said sum had been calculated in accordance with the scale mentioned in the award. That being the position, it cannot be said that the company was making a provision or building up a reserve fund to meet its future liability.
Mr. Joshi, appearing for the revenue, does not contend that making provisions for gratuity to meet the liability in that respect would amount to building up of reserves to meet a future liability. It is, however, his contention that the sum of Rs. 1,00,200 is in no way commensurate with nor represents the actual and factual liability of the assessee company up to that date. According to Mr. Joshi no amount was payable in 1947. Gratuity might become payable to its workers as and when a worker retires or has to cease ‑work on account of disability or death. It is, therefore, not possible to ascertain what sum then would become payable on account of gratuity. The basis and the mode by which the sum has been calculated is erroneous. A sum equivalent to the entire liability is not deductible in praesenti when that liability has to be discharged at a future date. We are not here concerned as to what sum, on this count, should have been allowed as a deduction in determining the distributable profits. The question is whether any sum should be allowed to be set apart to meet the liability in determining the amount of distributable profits. In our opinion, when liability in this respect had accrued, it was open for an assessee to make provisions to meet it as and when the question would arise. What sum should be allowed to be set apart is a matter for determination on considering the evidence, which the parties may choose to tender in this respect.
As regards the second item of Rs. 1,04,000, as already stated, the workers had demanded bonus equivalent to two months' salary every year but the award had granted bonus equivalent to 1 months' salary to them for the year 1946. The award, as already stated, was made on 18th March 1948 prior to the date of declaration of dividend. Calculating bonus for the year 1947 at the rate of two months' salary to its workers, the assessee company had set apart a slim of Rs. 1,04,000. It is contended by Mr. Joshi that so far as pay ment of bonus for the year 1947 was concerned, there was no accrued liability under the award. The award related only to the year 1446 and no liability was fastened on the assessee company of paying any bonus for the year 1947. A sum set apart to meet its accrued liability, no doubt, is deductible in determining the distributable profits of the company, but when there is no accrued liability any sum set apart to meet its future' liability would be in the nature of a reserve to meet its future liability and, therefore, not allowable.
It is not possible for us to accept this contention of Mr. Joshi in the form it is raised. It is indeed true that the award did not fasten any liability on the assessee to pay any bonus to its workers for the year 1947 and in that sense there was no accrued liability in that respect. But, then, the determin ation of distributable profits has to be done in a commercial sense. The employees were agitating for payment of bonus. They had been demanding bonus equivalent to two months' salary. For the previous year 1 months' salary had been granted as bonus by the industrial Court. In these circum stances, liability to pay bonus for the year 1947 at the rate of at least 1 months' salary was very imminent, may even certain in the event the assessee's business had made adequate profits. It was stated at the Bar that large profits were made during the year. If that be so, sums set apart to meet such imminent and certain liability, in our opinion, would be an allowable deduction in determining the distribut able profits in a commercial sense. It would not be reason able to say to a commercial man: "Even though tomorrow in all probability you will have to incur' this expenditure, you should not consider that aspect but distribute the profits, which are with you today without making any arrangement to meet the imminent expenditure." That, in our opinion, does not appear to be what section 23‑A requires a business man to do. The Tribunal, therefore, in our opinion, was not justified in refusing to take into consideration the sum of Rs. 1,04,000 in determining the issue as to the distributable profits of the assessee company on the ground that it is in the nature of a reserve to meet future expenditure. It is indeed true that by the award only 1 months' salary is directed to be paid as bonus. The sum set apart is on the basis of two months' salary. It is also true that, in the accounting year 1947, Rs. 89,000 and odd have been paid as bonus and has been allowed as a deduction. Mr. Joshi, therefore, next contends that the entire sum of Rs. 1,04,000 should, at any rate, not be allowed, but it should be reduced by the sum of Rs. 89,000 and odd which has already been allowed as a deduction in the accounting year 1947. We are not here concerned whether the entire sum of Rs. 1,04,000 should be allowed or any part thereof should be allowed in determining the issue of distributable profits. We are here concerned with ascertaining whether the Tribunal was justified in not taking into account at all the said sum in determining the distributable profits. As already stated, in our opinion, the Tribunal was not justified in doing so. What amount, if any, should be allowed to be set apart to meet its liability in respect of the bonus for the year 1947, will have to be considered on the evidence, which the parties may desire to put before the Tribunal.
For the reasons stated above, our answer to the reframed question is in the negative. The assessee shall have his costs from the Department.
Reference answered accordingly.
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