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Income‑tax Reference No. 48 of 1960, decided on 5th July 1962.

‑Distribution order‑Distri butable profits‑Profits Assessed to tax brought into accounts of earlier years‑Whether deductible‑Income‑tax Act (XI of 1922), S. 23‑A.

The assessee, a company to which the provisions of section 23‑A of the Indian Income‑tax Act, 1922, applied, had taken a building contract. For the purpose of its own accounting the assessee took into account the profits of the work every year as the work progressed and was completed from stage to stage. In the accounting year 1948‑49 a sum of Rs. 1,00,000 was credited in the assessee's books of account as profit arising out of the work and similarly a sum of Rs. 75,000 was credited in the books for the year 1949‑50. But the Income‑tax Officer brought these two sums amounting to Rs. 1,75,000 to tax in the assessment year 1951‑52, the relevant accounting year being 1950‑51:

Held, that as the assessee had brought into its accounts for 1948‑49 and 1949‑50 the, sums of Rs. 1,00,000 and Rs. 75,000 respectively as profits, in the absence of evidence to show that the assessee had not included them in the distribution of its dividends for those years, it could not be said that the sum of Rs. 1,75,000 was in the hands of the assessee in the accounting year 1950‑51. The sum had, therefore, to be deducted in determining the distributable profits for the year 1950‑51 for the purposes of section 23‑A.

New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income-tax (1959) 37 I T R 423 ref.

By this application, the Commissioner of Income‑tax, Bombay City I, Bombay, requires the Tribunal to refer to the High Court two questions of law, which are said to arise out of the Tribunal's order in I. T. A. No 10074 of 1958‑59. Inasmuch as, in our opinion questions of law do arise out of the aforesaid order of the Tribunal, we hereby draw up a statement of the case and refer it to the High Court of Judicature at Bombay under section 66 (1) of the Indian Income‑tax Act.

2. The assessee‑company is a private limited company carrying on the business of civil engineers and contractors. The relevant assessment year is 1951‑52, the accounting year being the year ended, March 31, 1951. For its own accounting purposes he works in progress were being taken into consideration in computing it profits. The department, however, for assessment purposes computed the profits on the basis of the completed contracts. One such contract which had taken three years for completion was the Sabarmati Broadcasting Station contract. The assessee had computed and returned the profit from such contract at Rs. 1 lakh for the year ended March 31, 1949, and Rs. 75,000 for the year ended March 31, 1950. The Department, on the other hand on the basis of its past practice assessed the profit of Rs. 1,75,000 in the relevant year of account, the year ended March 31, 1951, when the contract was completed. The Income‑tax Officer had added the profit of Rs. 6,51,023 as profit on account of revalua tion of shares. The company was thus assessed on an income of Rs. 13,38,913 for the assessment year 1951‑52. Provisions of section 23‑A were applied to the company on the ground that dividends declared, viz. Rs. 1,80,000, were inadequate.

3. The assessable income as determined by the Income‑tax Officer, viz. Rs. 13,38,913, was ultimately reduced to Rs. 676,390 on appeals to the Appellate Assistant Commissioner and the Tribunal. The income assessed as reduced by the income‑tax and super‑tax payable was Rs. 3,82,428. As the sum of Rs. 1,80,000 declared as dividend fell short of 60% of this sum the Income‑tax Officer applied the provisions of section 23‑A of the Act.

4. It was contended for the assessee before the Appellate Assistant Commissioner that for the purposes of section 23‑A the profit of Rs. 1,75,000 for the Sabarmati contract included in the total income for the assessment year 1951‑52 should be excluded for the purpose of considering the question as to the smallness of profit made by the assessee‑company. The Appellate Assistant Commissioner as to this contention held:

"I am of opinion that this sum of Rs. 1,75,000 pertaining to and included in the assessment year 1951‑52 should be excluded from the distributable surplus for the purpose of considering the question as to the smallness of profit made by the company. The net profit will then be Rs. 5,01,390."

The Appellate Assistant Commissioner thus conceded this point, but upheld the application of section 23‑A on the ground that the assessee was only entitled to deduct the tax and super tax on such commercial profits and not the taxed profits. Computing the tax on the commercial profits of Rs. 5,01,390 (Rs. 6,76,390 Rs. 1,75,000) and computing the tax thereon at Rs. 2,17,790,

according to him him, there was a balance of Rs. 2,83,600 available for distribution which could not be described to be "small" profits within the meaning of section 23‑A of the Act.

5. On appeal to the Tribunal, it was contended for the assessee that the tax to be deducted is not merely what is appropriate to the gross commercial profits but the actual tax liability as determined by the department and that if the actual tax liability of Rs. 2,93,807 was deducted from the said sum of Rs. 5,01,390 the balance left would be only Rs. 2,07,583 out of which Rs. 1,80,000 having been declared by way of dividend would be found to be very much more than 60% of Rs. 2,07,583 and to expect the assessee to declare a larger dividend would be unreasonable. Reliance was placed on the decision of the Bombay High Court in New Mahalaxmi Silk Mills Ltd. v. Commissioner of Income‑tax ((1959) 37 I T R 423).

6. The Tribunal for the reasons set out in its order dated December 10, 1959, upheld the finding of the Appellate Assistant Commissioner that the sum of Rs. 1,75,000 from the Sabarmati contract must be excluded in considering the smallness of commercial profits, but reversed his finding on the ratio laid down by the Bombay High Court in the aforesaid case of Not Mahalaxmi Silk Mills Ltd. and held that the tax which should be deducted is that which the assessee can be said to have reasonably anticipated. In the view of the Tribunal the anticipated tax liability provided for in the books by the assessee of Rs. 2,40,000 was by no means unreasonable. Considering that the actual tax liability which ultimately attached to the assessee was Rs. 2.97 lakhs and the fact which was known to the assessee that the profits of Rs. 1,75,000 on the Sabarmati Broadcasting Station contract would inevitably be brought to assessment by the Department in the relevant year of account, the assessee's estimate of tax liability at the time of declaring the dividend of Rs. 1,80,000 was not an inflated or an unrealistic figure from the reasonable commercial point of view. The Tribunal therefore, held that, though the order under section 23‑A could have been passed, it ought not to have been passed, in view of the smallness of profit.

7. From the above stated facts, the questions that arise are:

"(1) Whether, on the facts and circumstances of the case, the sum of Rs. 1,75,000 being the profit of the two preceding years but taxed in the relevant year of account in respect of the Sabramati contract, should have been taken into consideration in determining the distributable profits

(2) Whether, in determining the smallness of profits, the reasonable anticipated tax liability to be imposed by the income‑tax authorities could be taken into consideration "

8. Both parties agree that the facts have been correctly stated and no material facts have been omitted. The Department, however, requires that its question No. (ii) in the application, under section 66 (1) be also referred. This cannot be acceded to as the point raised was never in dispute, it being common ground that section 23‑A could be applied. The assessee objects to question No. I on the ground that the Appellate Assistant Commissioner having decided this point in favour of the assessee it was not a point in dispute before the Tribunal. Since, however, the finding of the Appellate Assistant Commissioner was concurred in by the Tribunal and the order of the Tribunal is based on it, the assessee's objection is overruled.

G. N. Joshi with R. J. Joshi for the Commissioner.

B. A. Palkhivala with N. A. Palkhivala and Dilip Dwarkadas for the Assessee.

Two questions have been; referred to us by the Tribunal under subsection (1) of section 66 of the Income‑tax Act at the instance of the Commissioner of Income‑tax. These questions are:

"(1) Whether, on the facts and circumstances of the case, the sum of Rs. 1,75,030, being the profit of the two preceding years, but taxed in the relevant year of account in respect of the Sabarmati contract, should have been taken into consideration in determining the distributable profits

(2) Whether, in determining the smallness of profits, the reasonably anticipated tax liability to be imposed by the income‑tax authorities could be taken into consideration "

Mr. Joshi, appearing for the revenue, stated before us that he does not press the second question, which has been raised by the Tribunal suo motu, in view of the decision of this Court in New Mahalaxmi Silk Mills Limited ((1959) 37 I T R 423). Facts giving rise to the present reference are that the assessee is a private limited company carrying on business of civil engineers and contractors. It is not in dispute that the provisions of section 23‑A are applicable to the assessee company. We are here concerned with the assessment year 1951‑52, the relevant accounting year being the one ending with 31st March 1951. It appears that the assessee company had, sometime in the year 1949, taken a contract to build the Sabarmati Broadcasting Station within a period of three years. The assessee‑company for the purpose of its own accounting had taken into account the profits of the work every year as the work progressed and was completed from stage to stage. In the accounting year 1948‑49, a sum of Rs. 1,00,000 was credited in the books of account of the assessee‑company as profits arising out of the said work. Similarly, in the accounting year 1949‑50, a sum of Rs. 75,000 was credited in its books of account as its profit arising out of business during the course of that year. It, however, appears that, even though the assessee‑company had shown Rs. 1,75,000 as profits accruing to it from the said business during these two years, the income‑tax authorities included the said two amounts aggregating to Rs. 1,75,000 in computing the profits of the assessee for the assessment year 1951‑52. After including the sum of Rs. 1,75,000 the Income‑tax Officer computed the assessable profits at Rs. 13,38,913. On further appeals to the Appellate Assistant Commissioner and the Tribunal, this sum however, was reduced to Rs. 6,76,390. The total distributable dividends declared by the assessee‑company during that year amounted to Rs. 1,80.000. That being less than 60 percent. of the assessable income, action under section 23A of the Income‑tax the Act was taken against assessee company. In these proceedings it was contended that the amount of Rs. 1,75,000 should be allowed as a deduction in con sidering the question of reasonableness or otherwise of the dis tribution of dividends having regard to the smallness of profits made by the company. The said amount of Rs. 1,75,000 has been allowed by the Income‑tax Appellate Assistant Commissioner and the Tribunal as an allowable deduction in determining the amount of distributable profits. In these circumstances, the aforesaid question No. 1 has been referred to us.

It is well settled that, in considering the reasonableness or otherwise of distribution of a larger dividend than one declared, what has to be taken into account is the distributable profits in the hands of the assessee and not the assessable income as: determined by the income‑tax authorities. Now it is not in dispute that Rs. 1,00,000 has been brought into account by the assessee in its books of account as profits for the year 1948‑49 and similarly Rs. 75,000 has been brought in its books of account by the assessee as profits for the year 1949‑50. There is no evidence that, in spite of bringing these amounts in its books of account as profits, the assessee has kept them apart and not included in the distribution of its dividends in the years 1948‑49 and 1949‑50. That being the position, it cannot be said that the sum of Rs. 1,75,000 was a sum in the hands of the assessee in the relevant accounting year 1950‑51. In these circumstances in our judgment, the Tribunal was right in holding that it was an allowable deduction in determining the distributable profits.

Our answer to the first question, therefore, is in the negative. The Commissioner shall pay the costs of the assessee.

First question answered in the negative.

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