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Income‑tax Reference No. 16 of 1961 decided on 20th August 1962.
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----‑Undistributed profits‑Distribution order‑Excep tion‑Smallness of profits‑Amount paid to compromise protracted litigation‑Whether deductible‑‑Indian Income‑tax Act, 1922, S. 23‑A.
For the assessment year 1952‑53 the balance of profits avail able for distribution, of the assessee, a company in which the public were not substantially interested, was computed a" Rs. 1,32,054. As only a sum of Rs. 64,000 was distributed as dividend, the Income‑tax Officer made a distribution order under section 23‑A of the Indian Income‑tax Act, 1922. The assessee contended that in determining the profits available for distribution before a distribution order could be made, the sum of Rs. 21,320, which it had paid as secret commission, had to be deducted. This the Appellate Assistant Commissioner allowed. The assessee contended that a sum of Rs. 50,000 paid to one D in pursuance of a compromise to end protracted litigation had further to be deducted. That amount came to be paid in the following circumstances. The assessee and D were the partners of a firm which was the managing agent of the Estrella Batteries Ltd. That firm had resigned its managing agency. D instituted a suit in 1947 alleging that the signature to the letter of resignation was not properly obtained and claimed compensation for loss of agency. In this suit the assessee was made a pro forma defendant.
The suit was ultimately compromised in 1951, the assessee agreeing to pay D Rs. 1,25,000 and D agreeing not to prosecute the suit any further. D was paid Rs. 50,000 in the relevant year of account. The Appellate Tribunal held that even though the sum of Rs. 50,000 might not be deductible for purposes of assess tax the payment was made to get rid of a disturbing element in the assessee s business and had to be deducted to ascertain the profit available for distribution and that, therefore, section 23‑A was wrongly applied. On a reference :
Held, that the Tribunal was right in holding that the sum of Rs. 50,000 had to be deducted in ascertaining the distributable profits for the purpose of section 23‑A.
By this application, the Commissioner of Income‑tax requires the Appellate Tribunal to state a case to the High Court on certain questions of law which are said to arise out of the Tribunal's order in I. T. A. No. 12977 of 1958‑59. Inasmuch as, in our opinion, a question of law does 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 Maharashtra at Bombay under section 66(1) of the Indian Income tax Act, 1922.
2. The assessee is a company in which the public are not substantially interested within the meaning of section 23‑A of the Income‑tax Act. As per the profit and loss account the income of the assessee for the relevant previous year was Rs. 1,33,750. The accounts are closed at the end of the Samvat Year 2007 ending on October 30, 1951. The annual general meeting was held on June 20, 1952. A sum of Rs. 64,000 was distributed as dividends at this meeting.
3. The company submitted a return of income on October 9, 1952, for the assessment year 1952‑53 showing an income of Rs. 1,56,894, The total income assessed amounts to Rs. 2,33,466. The tax payable thereon was worked out at Rs. 1,01,412. The balance available out of the assessed income as per the assessment order dated July 31, 1954, is Rs. 1,32,054. The departmental authorities held that the amount of dividends declared by the assessee was less than 60%. of the assessable income of the company as reduced by the amount of income tax and super‑tax payable in respect thereof. The Income‑tax Officer was not satisfied about the existence of any circumstances like smallness of the profits as a result of which payment of dividends larger than that declared would be unreasonable. He, therefore, made an order that the undistributed portion of the income of the assessee‑company as reduced by the amount of tax payable thereon be distributed as dividends amongst the shareholders.
4. The adjustments which raised the income of the assessee to a figure of Rs. 2,33,466 as against Rs. 1,33,750 shown in the P. & L. account or Rs. 1,56,894 shown in the return included among others a sum of Rs. 50,000 which was paid to one Dr. Jariwala. The facts relating to this payment are as follows :
There was a firm known as Choonilal and Jariwala who were the managing agents of Messrs Estrella Batteries Ltd. The managing agency firm of Messrs Choonilal and Jariwala was composed of two partners, viz. the assessee and one Dr. L. C. Jariwala. This firm resigned its office of managing agents by its letter dated April 22, 1947. Messrs Estrella Batteries Ltd. accepted the resignation. Thereafter, Dr. L. C. Jariwala filed a suit in the Bombay High Court, Suit No. 3462 of 1947, alleging that the signature to the letter of resignation of the managing agency was not properly obtained and that a sum of Rs. 8 lakhs must be paid as compensation for loss of agency.
5. The respondent‑company, Choonilal Manilal Ltd. was impleaded therein as a second defendant. The litigation was protracted. Ultimately by letter dated April 5, 1951, the claim between the parties was compromised, whereby Dr. Jariwala agreed not to prosecute the suit on payment of Rs. 1,25,000 by the respondent herein of which Rs. 50,000 was paid during the year of account of S. Y. 2007. This was claimed as a deduction in the assessment for 1952‑53, which was not allowed. The assessee filed an appeal against the disallowance of this item but was unsuccessful.
6. Another item of expenditure which was disallowed was a sum of Rs. 21,320. The assessee's main business is in coal. It was stated that a sum of Rs. 21,320 was paid as secret commission to certain of the buyers of coal. There were no details regarding these payments. Hence they were disal lowed. There was no appeal on this disallowance.
7. Before the income‑tax authorities in the section 23‑A proceeding it was contended that these items of expenses have' to be allowed in order to see the available profits which the assessee could have distributed. The Income‑tax Officer did not consider this claim of the company to be correct.
The Appellate Assistant Commissioner appeared to agree that to the extent of Rs. 21,320 the assessee might have a case as he felt that the necessity of paying commission in a business of this type arose sometimes. The Appellate Assistant Com missioner did not consider that the sum of Rs. 50,000 was to be taken into account for computing the available profits, He held that even after allowing Rs.21,320 the distributed profits fell short of the 60% referred to in section 23‑A.
8. The Tribunal agreed with the Appellate Assistant Commissioner in the view that the assessee had a case for the deduction of the sum of Rs. 21,320 in computing the available profits for section 23‑A. On the sum of Rs. 50,000 also the Tribunal took the view that the amount hail to be taken into account as an outgoing having regard to the scope and object of section 23‑A. The fact that the gum of Rs. 50,000 had gone out of the coffers of the company was not in dispute. Hence, it was held that this sum could not be the subject of distribution as dividends by the company. If this sum of Rs. 50,000 was deducted in arriving at the distributable profits, then the assessee had distributed the requisite percentage. The order of the Tribunal is annexed hereto as Annexure "A" and forms part of the case.
9. On these facts, the Commissioner of Income‑tax requires us to refer the following questions of law :
"(1) Whether, the sum of Rs. 50,000 paid to Dr. Jariwala could be taken into account for the purpose of determining the smallness of the profits made by the company', for the purposes of section 23‑A of the Act
(2) Whether in the circumstances of the case the Tribunal was justified in holding that section 23‑A was not properly applied in this case "
10. In our opinion, the following is the question of law that arises :
"Whether, on the facts and in the circumstances of the case, the sum of Rs. 50,000 being the amount paid to Dr. Jariwala as per the compromise was deductible in considering the application of section 23‑A."
11. Both parties agree to the statement of facts given above. The Departmental Representative suggested that the second question as given in the reference application should also be referred or in the alternative that in the question as framed by us reference may be made to the sum of Rs. 21,320 also. Mr. Palkhivala objected to this suggestion on the ground that the second question as given in the reference application was vague and did not bring out the controversy between the parties, and that no reference should be made to the sum of Rs. 21,321 in the question as the Department did not ask fur this in the application filed by them. We agree with the objection raised by the learned counsel for tire company and reject the suggestion made by the Departmental Representative We consider that by specifically raising a question in respect of Rs. 50,000 alone, and by not raising any point regarding Rs. 21,320 in the question as framed by them, the Department cannot at this stage ask for a reference to that sum also. We have, however, given all the facts which are accepted as correct so that the statement of the case will be full.
G. N. Joshi with R. J. Joshi for the Commissioner.
N. A. Palkhivala with S. P. Mehta, Y. S. Trivedi, U. T. Shah and S.J. Mehta for the Assessee.
‑This is a reference under subsection (1) of sec tion 66 of the Indian Income‑tax Act (hereinafter referred to as the Act) at the instance of the Commissioner of Income‑tax. The question referred to us is in the following terms :
"Whether, on the facts and in the circumstances of the case, the sum of Rs. 50,000 being the amount paid to Mr. Jariwala as per the compromise was deductible in considering the application of section 23‑A "
The following facts give rise to this question : The assessee is a company in which the public are not substantially interested within the meaning of section 23‑A of the Act. For the assessment year 1952‑53, it returned an income of Rs. 1,56,894. The Income‑tax Officer, however, after disallow ing certain expenditure said to have been incurred by the company, computed its income at Rs. 2,33,466. The tax payable thereon was worked out at Rs. 1,01,412. The balance available for profits as per the assessment order of date 31st July 1954, was Rs. 1,32,054. The Income‑tax Officer, finding that the dividends declared by the assessee company was less than 60% of the assessable income of the company is reduced by the amount of income‑tax and super‑tax payable in respect thereof, made ate order under section 23‑A that the undistributed portion of the income of the assessee as reduced by the amount of tax payable thereon be deemed to be the dividends distributed among the shareholders. It appears that before the Income‑tax Officer the assessee had contended that it had to pay Rs. 21,320 as secret commission for the purpose of its business and this should be take: into account in determining the smallness of the profits. It was also the contention of the assessee that it had paid a sum of Rs. 50,000 to Dr. Jariwala in the year of account in pursuance of a compromise arrived at between Dr. Jariwala on the one hand and the company on the other in a then pending litigation. The assessee‑company claimed that this item should also be taken into account in determining the issue of smallness of profits. According to the assessee if these amounts are taken into account in determining the available profits for distribution, it could not be said shat the assessee‑company could have reasonably distributed dividend larger than those distributed by the company.
At this stage it would be convenient to mention the circumstances which gave rise to the litigation started by Dr. Jariwala. It appears that, prior to the year 1947, there was a partnership firm known as "Chunilal and Jariwala" consisting of two partners, the present assessee‑company and Dr. Jariwala. This partnership firm, i.e. "Chunilal Jariwala", were the managing agents of Messrs Estrella Batteries Ltd. This firm resigned its managing agency by its letter dated April 22, 1947, and the resignation was accepted by Messrs Estrella Batteries Limited. Thereafter, Dr. Jariwala filed a suit in this court (Suit No. 3462 of 1947) alleging that the signature to the letter of resignation of the managing agency was not properly obtained and that a sum of Rs. 8 lakhs must be paid as compensation for loss of agency. The suit was filed both against Messrs Estrella Batteries Ltd. and the assessee‑company, the assessee‑company being the second defendant therein. After a protracted litigation the suit was ultimately compromised on terms as mentioned in a letter dated April 5, 1951, the assessee‑ company agreeing to pay a sum of Rs. 1,25,000 to Dr. Jariwala and Dr. Jariwala agreeing not to prosecute the suit further Out of the said amount of Rs. 1,25,000, Rs. 50,000 have been paid by the' assessee company to Dr. Jariwala in the year of account. As already stated, the assessee had claimed before the Income‑tax Officer that the aforesaid sums of Rs. 21,320 and Rs. 50,000 should be excluded in determining the issue of smallness of profits and profits available for distribution amongst the members. This contention was, however, not accepted by the Income‑tax Officer and he made an order under section 23‑A. The assessee took an appeal before the Appellate Assistant Commissioner. The Appellate Assistant Commissioner. accepted the contention of the assessee in respect of the amount of Rs. 21,320, but did not accept the contention of the assessee in respect of the said amount of Rs. 50,000 paid to Dr. Jariwala in the year of account. The reasons given by the Appellate Assistant Commissioner have not been stated in the statement of case, but the order has been read to us and it appears that he disallowed the amount on the ground that the expenditure was of a capital nature. He held that even after allowing the amount of Rs. 21,320, the distributed profits fell short of 60 % and, in this view of the matter, he affirmed the order of the Income‑tax Officer. The assessee took a further appeal to the Income‑tax Appellate Tribunal and the Tribunal has accepted the contention of the assessee and allowed the appeal.
To appreciate the argument of Mr. Joshi, learned counsel for the revenue, it would be convenient to reproduce para graphs 6, 7 and 8 of the order of the Tribunal containing its reasons for allowing the appeal :
"6. After carefully considering the matter, we are of the opinion that the assessee must succeed. Section 23‑A is a highly technical anti‑avoidance device. Its main purpose is to stop the avoidance of super‑tax by the simple means of not distributing the dividends and carrying forward the profits, either as reserves or as unappropriated profits which is quite easy when the company is controlled by a few persons having large incomes. To plug this loop‑hole it was enacted in the year 1939 that the Income‑tax Officer could pass an order under section 23‑A whereby the profits available for distri bution after paying taxes and dividends could be deemed to be distributed as dividends. The right of the Income‑tax Officer is not unfettered ; he has to consider the smallness of profits and the previous losses ; nor is it to be done by a rule of thumb because the Courts have held that the com mercial profits should be considered as available for distribu tion whatever the total income assessed may be.
7. It is necessary to discuss this last aspect in a little more detail because our present case turns on this. The main reason why commercial profits are to be considered for the purposes of section 23‑A is that otherwise the Income‑tax Officer may order that a dividend is deemed to be distributed when there is no profit at all to be distri buted. A payment may be made‑an actual and genuine payment to an outsider‑so that no profit is left for distri bution ; this however, may be disallowed in an income‑tax assessment for good and valid reasons and though there is no avoidance of super‑tax‑the raison d'etre for section 23‑A still the Income‑tax Officer would hold that a dividend is deemed to be distributed. This is exactly what has happened in the present case. Rs. 50,000 has been paid. If the company had funds which could be distributed and still not distributed it, the position would have been entirely different, but now the company has parted with this money and nothing is left in the coffers to distribute. We have, therefore, no hesita tion in holding that section 23‑A was not properly applied in this case.
8. During the arguments it was also suggested that the company should not have charged it against the profits of company, but debited it to some capital account because the payment is of a capital nature. The payment was unmistakably made to get rid of a disturbing element and we doubt whether any auditor could allow it to be capitalised. No asset of enduring nature has come in and we are of the opinion that the payment has been properly charged to revenue even though it is not deductible for income‑tax assessment and only after the deduction of Rs. 50,000, one could arrive at the commercial profits. We, therefore, do not accept this contention of the Departmental Representative either."
It is the contention of Mr. Joshi that section 23‑A. has been misconstrued by the Tribunal. The only ground on which the Tribunal has accepted the contention of the assessee is that the sum had gone out of the coffers of the assessee‑company. According to Mr. Joshi the mere fact that an assessee has expended a part of its profits is not sufficient to entitle him to claim that that amount be excluded in computing the amount of available profits for the purpose of section 23‑A. In order to enable the assessee to claim a deduction of any amount expended by it, out of its profits, it must be established that the expenditure is in some way or the other connected with the business of the assessee. The managing agency was terminated in 1947. In 1951 when the payment was made the managing agency was not in existence. There was no reason for the assessee to make any payment to Dr. Jariwala in the year 1951. According to Mr. Joshi even Dr. Jariwala in his suit had claimed no relief against the assessee‑company, but, on the other hand, the assessee‑company was joined as a pro forma defendant because it had refused to join Dr. Jariwala as a plaintiff. Mr. Joshi stated before us that Dr. Jariwala had even asked the Court that the amount claimed by him be decreed in favour of himself as well as the assessee‑company. In the alternative Mr. Joshi contends that the expenditure is of a capital nature. The assessee‑company wanted to secure afresh the managing agency of Messrs Estrella Batteries Limited to itself and to the exclusion of Dr. Jariwala and it is for this purpose that it had agreed to pay to Dr. Jariwala a sum of Rs. 1,25,000 towards which the amount of Rs. 50,000 has been paid. The payment, therefore, is of a capital nature. The finding of the Tribunal contained in paragraph 8 that "the payment was unmistakably made to get rid of a disturbing element" is without any evidence to support it. At any rate the finding is too cryptic and the Tribunal be called upon to submit a supplemental statement showing how the payment was made to get rid of a disturbing clement. We find it difficult to accept Mr. Joshi's contentions.
Now, section 23‑A confers a right on the Income‑tax Officer to make an order in writing that undistributed portion of the assessable income of the company of the 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 among the shareholders as at the date of the general meeting and thereupon the proportionate share thereof of each of the shareholders shall be included in the income of such shareholder for the purpose of assessing his total income. This right conferred on the Income‑tax Officer is dependent on the existence of certain circumstances. Firstly, the Income‑tax Officer has to satisfy himself that in respect of any previous year the profits and gains distributed as dividends by any company up to the end of six months after its account for the previous year are laid before the company in general meeting are less than 60 % of the assessable income of the company of the previous year as reduced by the amount of income‑tax and super‑tax payable by the company in respect thereof. But this by itself is not sufficient to enable the Income‑tax Officer to make the aforesaid order. The Income‑tax Officer has further to satisfy himself that, having regard to the losses incurred by the company in previous years or to the smallness of profits made, the payment of a dividend or a larger dividend than that declared would be unreasonable. Now, in considering the issue as to the smallness of profits, it has been well settled that the Income‑tax Officer has to take into account the commercial profits of the company and not the assessable income of the company. Certain amounts may not be allowable as expenses wholly and exclusively laid out for the purpose of business in the assessment of the company, but nevertheless they may be genuine payments and could be claimed as deductions in ascertaining the commercial profits of the assessee. The commercial profits of an assessee is not one and the same thing as the assessable income of an assessee. It is after ascertaining the commercial profits of the company that the Income‑tax Officer has further to consider whether payment of dividend or a larger dividend than that declared would be unreasonable. It is only when the Income‑tax Officer is so satisfied that declaration of a larger dividend than that declared would not be unreasonable that he is entitled to make an order under section 23‑A. it is not in dispute before us that for an assessee to claim a deduction of an amount in computation of its commercial profits, the expenditure has to be in some manner connected with the business of the assessee. An expenditure incurred, which has no connection whatsoever with the business, cannot be claimed as a deduction. It has to be seen whether as contended by Mr. Joshi the Tribunal has allowed this sum to be deducted from the computation of profits simply because it has been paid to a stranger. We are unable to read the finding contained in paragraph 7 in the manner Mr. Joshi would like us to read it. In our opinion, what the Tribunal has found is that it is an actual and genuine payment made and that indicates that it is a payment having connection with the business and not a payment having no connection with the business. It may be true, as Mr. Joshi contends before us, that in the plaint no relief was claimed against the assessee- company, who was merely joined as a co‑defendant. On the other hand, the decree claimed by Dr. Jariwala was one jointly in favour of himself and the assessee‑company. But it is not possible, to accept that to be the real position. From the order of the Tribunal it is not possible to say that that was the position. Also from the order of the Tribunal it does not appear that any question in the form now raised before us had been raised before the Tribunal. It was open to the Department to urge this ground before the Tribunal if there was any substance in it. As we find from the order of the Tribunal and the statement of the case, the litigation was a protracted one ; the litigation appears to have been instituted some time in the year 1947 and the compromise took place in the year 1951. What form the litigation had taken by 1951 is not known and whether the position as it initially was had remained still the same position in the year 1951 also is not known. In these circumstances it is difficult to assume that the payment was made without any rhyme or reason by 'the assessee -company. Further it does not appear from the order of the Tribunal that there was any contention raised before it that the payment was not bona fide made in pursuance of the compromise or that the compromise was not a bona fide compromise. On the other hand, it appears that the conten tion raised was two‑fold : that the payment of Rs. 50,00 which was not allowed in the assessment, was not allowable as a deduction for purposes of section 23‑A also and alternatively, at any rate, it being a payment of a capital nature, could not be claimed as a deduction, That being the the position, it is not possible to hold that the finding of the Tribunal contained in paragraph 7 that the payment was an actual and genuine payment is in any manner vitiated. Further it does not appear that there was any contention raised before the Tribunal that the payment, was a payment which was in no manner connected with the business of the assessee. On the other hand, the ground on which the Appellate Assistant Commissioner has rejected the contention of the assessee was that it was a payment of a capital nature.
Now, a payment, which is of a capital nature, cannot be said to be a payment unconnected with the business. That finding of the Appellate Assistant Commissioner, however, has not been accepted by the Tribunal. Before us Mr. Joshi has argued that the payment was made by the assessee to Dr. Jariwala because the assessee‑company wanted to get rid of Dr. Jariwala and secure afresh the managing agency of Messrs Estrella Batteries Limited. The case does not appear to have been put in that from before the Tribunal. The Tribunal has found that the payment was made to get rid of a disturbing element. This is a finding of fact and, having regard to the context and the long pendency of the litigation against the company for over four years it appears that Dr. Jariwala was a disturbing element to the business of the assessee.
For reasons stated above, in our opinion, the answer, on the facts found by the Tribunal, will have to be in favour of the assessee. Our answer to the question referred to us, therefore, is in the affirmative. Commissioner shall pay the costs of the assessee.
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