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Income‑tax Reference No. 51 of 1961, decided on 30th April 1964.
‑‑‑‑ S. 23 A (1), proviso‑Assessment of Company‑Accumulated profits and reserves exceeding paid‑up capital or cost of fixed assets- Provision of S. 23‑A(1) applicable if whole of total income not distributed as dividend‑Expression "paid‑up capital"‑Held, refers to paid‑up capital at relevant point of time and not to what share holders had originally contributed but does not include bonus shares paid out of profit ‑ Word "reserves"‑Does not include profits adjusted against value of goodwill or set apart as gratuity fund.
The paid up capital of the assessee‑Company when it was incorporated was Rs. 28 46 700 consisting of 28,467 paid‑up shares of Rs. 100 each. The company suffered losses amounting to Rs. 23,94,210 and in order to wipe out the loss the company reduced its capital to 5,69,340 consisting of 28,467 shares of Rs. 20 each. A sum of Rs. 5,70,000 was added to the capital by issue of bonus shares of the value of Rs. 3,50,000 out of revenue reserves and of the value of Rs. 2,20,000 by capitalising capital reserves and the paid‑up capital thus stood at Rs. 11.40,000. The total accumulated pro fits and reserves according to the Appellate Tribunal amounted to Rs. 13,04,554 and the cost of fixed assets was computed at Rs. 12,22,000. As the company had not distributed the whole of its total income, sec tion 23‑A(1), proviso (b) was applied. The company contended that the paid- up capital was the original capital distributed by the shareholders, viz. Rs. 28,46,700 and at any rate Rs. 4,00,000 which had been written off from the value of the goodwill and Rs. 78,500 set apart as "gratuity fund" as directed by awards of the Labour Courts should not be included in the reserves and if there amounts were excluded the accumulated profits and reserves could not exceed the paid‑up capital or cost of fixed assets and as such sec tion 23‑A could not apply.
Held, that‑(i) "paid‑up capital" of the company for the purposes of the proviso means what the company holds as its paid‑up capital at the rele vant point of time and not what the shareholders had originally con tributed. The Tribunal was however not right in including the sum of Rs. 3,50,000 distributed as bonus shares as his amount was made up from accumulated profits and the correct paid‑up capital was therefore, Rs. 7,90,000;
(ii) Rs. 4,00,000 written off against the value of the goodwill must be deducted from the accumulated profits and reserves even though the goodwill was treated as a fixed asset;
(iii) Rs. 78,500 set apart for "gratuity fund" to comply with the award of the Labour Courts could not be treated as a reserve and was also deductible from the accumulated profits and reserves; and
(iv) As the amount of accumulated profits and reserves properly calcu lated was far less than (a) the paid‑up capital and (b) cost of fixed assets, section 23‑A(1), proviso was not applicable to the case and the order of the Income‑tax Officer under section 23‑A cannot be sustained.
Commissioner of Income‑tax v. Century Spinning do Manufacturing Co. Ltd. (1955) 24 I T R 199.; Creaves Cotton of Crompton Pakistan Ltd. v. Commissioner of Income‑tax (1968) 48 I T R 20; Jubilee Mills Ltd. v. Commis sioner of Income‑tax (1964) 51 I T R 683 and Stapley v. Read Brothers Ltd. (1924) 2 Ch. 1 ref.
By this application the assessee requires the Appellate Tribunal to refer to .he High Court certain questions of law said to arise out of the order of the Tribunal in I. T. A. No. 8103 of 1959‑60. 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 judicature at Bombay under section 66(1) of the Indian Income‑tax Act, 1922.
2. This reference arises out of proceedings under section 23‑A. The assessee is a company coming within the scope of that provision. The asses ment year under reference is 1956‑57 and the relevant accounting year is the year ended March 31, 1956. The company declared as dividend a sum of Rs. 99,750 in respect of the profits of the year ended March 31, 1956, at the annual general meeting held on November 8, 1956. The relevant figures for considering the application of section 23‑A in this case are as follows:
| Rs. | |
| Income assessed | 3,13,830 |
| Taxes payable thereon | 1,38,222 |
| Balance available out of assessed income | 1,75,608 |
| Divided declared | 99,750 |
| Profit as per profit and loss account subject to provisions for taxation | 2,80,288 |
In the opinion of the Income‑tax Officer, the declaration of Rs. 99,750 as shown above did not satisfy the provisions of section 23‑A and as the dividend declared was more than 55 % of the total income minus the income‑tax and super‑tax payable thereon, the Income‑tax Officer gave the company an opportunity to declare further dividends to bring up the declaration to the extent contemplated by section 23‑A, viz. Rs. 1,75,608, as the company had to declare the whole of the balance out of the assessable profits. The company did not avail itself of this opportunity as in its view it had declared dividends which taken along with the excess declaration of earlier years, satisfied the requirements of section 23‑A. In substance, the company's position was that it had to declare only 60% of the profits computed as provided under section 23‑A while according to the Income‑tax authorities the company had to declare the whole of its available profits as computed under section 23‑A. In the view of the authorities, the company came within the proviso (b) to section 23‑A(1) as it stood during the relevant year so that Rs. 1,75,608 should have been declared as dividends and not merely Rs. 99,750. The Income‑tax Officer and on appeal the Appellate Assistant Commissioner and the Tribunal have held that the above‑mentioned proviso applies. The assessee disputes this decision. For purpose of convenience of reference, we may rejroduce here the relevant proviso which runs as follows:--
(b) in the case of any other company where the accumulated profits and reserves (including the amounts capitalised from the earlier reserves) representing accumulations of past profits which have not been the subject of an order under this subsection, exceed either the aggregate of
(i) the paid‑up capital of the company exclusive of the capital, if any created out of its profits and gains which have not been the subject of an order under this subsection, and
(ii) any loan capital which is the property of the shareholders, or the actual cost of the fixed assets of the company, whichever of these is greater,
this section shall apply as if for the words, "sixty percent of the total income" wherever they occur, the words "the whole of the total income" had been substituted.
3. The proviso contemplates the accumulated profits and reserves being compared and contrasted with (a) the paid up capital, or (b) the actual cost of the fixed assets, whichever of these is greater. There is no loan capital being the property of the shareholders. Thus reference to the figures which compose the accumulated profits, paid up capital, and the actual cost of the fixed assets become necessary. It is also necessary for purposes of this reference to set out the history of capital structure of the company. .
4. The company was incorporated in or about 1919. Then its paid capital was Rs. 28,46,70 consisting of the capital issued and paid up alt 28,4 shares of Rs 100 each. The slump after the First World War affected the fortunes of this company. It suffered losses. The losses suffered in 1923-24 including the carried forward losses of earlier years totalled Rs. 23,94,210. In order to wipe out this large loss, the company passed appropriate resolutions for reducing the paid up capital from Rs. 28,46,700 to Rs. 5,69,340 and adjusting the reduction in capital as against the losses. The requisite sanction of the Court for confirming the reduction of capital as contem plated by the Indian Companies Act, 1913, was also obtained. After reduction, the capital of the company stood at Rs. 5,70,600 for a long time until some reserves were capitalised and bonus shares were issued in 1948 and 1949. (We may mention at this stage only to clarify the facts that the reduced. capital of Rs. 5,69,340 was increased to Rs 5,70,000 by issuing certain forfeited shares). The reduction in capital in 1924 did not involve any repayment of capital to the shareholders.
5. There were two issues of bonus shares on February 6, 1948, and December 1, 1949, under which the capital was increased by a sum of Rs. 5,70,000. For this bonus issue, a sum of Rs. 3,50,000 was utilised out of what can be called revenue reserves, i.e., reserves created earlier out of revenue profits, and the balance of Rs. 2,20,000 was met by capitalising capital reserves.
6. The company when it was formed paid a sum of Rs. 5,00,000 for goodwill. This amount was written off by appropriation out of the profit and loss account for the year 'ended March 31, 1921, to the extent of Rs. 4,00,000 and the balance of Rs. 1,00,000 was written off out of the profit and loss account for the year ended March 31, 1924, when the company had sustained a loss. The sum of Rs. 1,00,000 thus went to increase the loss which was ultimately wiped off by reduction of capital mentioned in paragraph 4 above.
7. With this background of the company's earlier balance sheets, we may now turn to the figures given in the accounts of the company for the year ended March 31, 1956. The balance‑sheet and profit and loss account as at March 31, 1956, are annexed as Annexure "A". The relevant figures as per the same are given below:
| Rs. Rs, Capita: issued, subscribed and paid up: 28,500 shares of Rs. 20 each fully paid up in 5,70,000 crash; 28,500 shares of Rs. 20 each issued as fully paid up without payment being received in cash being made up as follows From capitalised reserve fund 3,50,000 From capitalised capital reserve 2,20,060 5,70,000 11,40,000 opening balance 12,326 General reserve: 3,10,000 Capital reserve: 1,63,702 which contains assessable or assessed capital gains of Rs. 27,431 Investment depreciation reserve: 1,26,297 Gratuity fund: 78,500 |
8. We may first take up the figures regarding accumulated profits and reserves as the total of these has to be compared with the paid up capital and actual cost of fixed assets. There is no dispute that the following figures among those mentioned above constitute "accumulated profits and reserves" coming within the proviso (b) to section 23‑A(l) viz.,
| Rs. | |
| Profit and loss account opening balance | 12,326 |
| General reserve | 3,10,000 |
| Reserves capitalised out of the revenue profits | 3,50,000 |
| 6,72,326 |
Therefore it is necessary to consider only the other figures given above in paragraph 7 which relate to accumulated profits and reserves.
9. The parties are now agreed that a sum of Rs. 27,431 is the assessed or assessable capital gains included in the capital reserve of Rs. 1,63,702 mention ed in paragraph 7 above. There is no dispute that to this extent, viz. Rs. 27,431 the reserves as mentioned in paragraph 8 above require to be increased.
10. In the figures in paragraph 7 there is a sum of Rs. 1,26,297 shown as investment depreciation reserve. That this is a reserve created out of revenue profits is not disputed. But the assessee‑Company claims that the book value of investments is Rs. 2,34,300 while the market value of the same is Rs. 1,50,803. To the extent of .the difference between the two figures given above (Rs. 2,34,300 minus Rs. 1,50,803=Rs. 83,497) adjustment was claimed. There is no specific discussion of this in the orders of the Income‑tax Officer and the Appellate Assistant Commissioner. The Tribunal has dealt with the contentions on this point in paragraphs 21 and 22 of its order annexed hereto as Annexure "B". In the Tribunal's view, the Act does not contemplate or provide for such adjustments, the purpose for which the reserve is created being immaterial, and hence the sum of Rs. 1,26,297 is liable to be taken as a reserve.
11. The next item is the gratuity reserve of Rs.78,500. That it was a reserve or fund created out of profits was not in dispute.. This amount was intended to meet the liability which fell on the company as a result of a labour award on August 16, 1949. On this point also, there was no specific discussion in the orders of the authorities below. Even without this amount, the reserves appearing in the balance‑sheet exceeded the paid up capital or actual cost of fixed assets as will be clear from what follows. The Tribunal however, went into the admissibility of this claim, and found that there is nothing in law which would warrant ignoring this amount. In the opinion of the Tribunal, as set out in paragraph 33 of its order so long as it was a reserve, it was liable to be included in the computation of accumulated profits and reserves, notwithstanding the purpose for which it was intended to be utilised.
12. We have so far dealt with the figures as per the balance‑sheet. It becomes necessary to mention another item which does not appear in the balance‑sheet, so as to see whether the amount is liable to be treated as part of "accumulated profits and reserves". It has been mentioned earlier in this statement in paragraph 6 that the company had paid for goodwill a sum of Rs. 5 lakhs which found a place in its accounts. This goodwill was written off to the extent of 4 lakhs out of profits for the year ended on March 31, .1921, and to the extent of Rs. 1 lakh in the profit and loss account for the year ended March 31, 1924. The latter sum does not represent an actual appropriation out of the profit and loss account because the company sustained a loss in 1924 and the adjustment of this amount merely increased the loss. This loss has also been wiped off only by reduc tion of capital in 1924. ‑Thus the actual amount that went out of the profit and loss account to wipe off goodwill is Rs. 4 lakhs. Though the company did not show goodwill as an asset, in its balance‑sheet (Annexure "A"), it claimed that this sum of Rs. 5 lakhs has to be restored to its place as an asset in the accounts, as what the proviso contemplates is the "actual cost of the fixed assets". That goodwill is a fixed asset and that its actual cost was Rs. 5 lakhs were not in dispute. The Department, however, contended that the goodwill has disappeared, by the company suffering huge losses in the post‑war years and that in the alternative if goodwill was brought in as an asset, the amount abjused out of the profits for writing off the goodwill should be brought in again to compute the "accumulated profits and reserves". The Tribunal has discussed the respective contentions of parties in paragraphs 28 to 31 of Annexure "B". Its conclusion was that the goodwill will have to be taken as fixed asset, as its writing off in the accounts of the company did not destroy its existence or value which had been paid for. It was also held that correspondingly Rs. 4 lakhs adjusted out to past profits in 1921 for writing off goodwill should be taken into account for computing accumulated profits and reserves.
13. The total accumulated profits and reserves as per the Tribunal's order and the assessee's contention are as follows: ‑
| Name or category of reserve | Tribunal's computation | Assessee's computation |
| Rs. | Rs. | |
| P. & L. account opening balance | 12,326 | 12,326 |
| General reserve | 3,10,000 | 3,10,000 |
| Reserve capitalised | 3,50,000 | 3,50,000 |
| Capital gains included in capital reserve | 27,431 | 27,431 |
| Profits adjusted for writing off goodwill | 4,00,000 | Nil |
| **Investment depreciation reserve | 1,26,297 | Nil |
| Gratuity fund | 78,500 | Nil |
| Total | 13,04,554 | 6,99,757 |
**Subject to an alternative Contention that if at all only the excess over Rs. 83,497 is to be taken into account as reserve vide paragraph 10 above.
14. Having arrived at the accumulated profits and reserves at Rs. 13,04,554 it has to be compared with the paid up capital of the company to see if the paid up capital exceeded reserves. The paid up capital as per the balance‑sheet for the relevant year is Rs. 11,40,000 of which Rs. 5,70,000 is fully paid up in cash. The balance of Rs. 5,70,000 is the‑capital issued as fully paid up by capitalising certain reserves. As already pointed out, there is no dispute about a sum of Rs. 3,50,000 being capitalised out of reve nue reserves. As such, as authorised by the provision, this has been taken in the computation of reserves. As far as the balance of Rs. 2,20,000 out of the bonus issue was concerned, it was capitalised out of capital profits. There was nothing in the records to show that was not capitalised out of capital profits. The department's contention was that this sum of Rs. 2,20,000 is also liable to be excluded from paid‑up capital as it was capitalised out of reserves. This contention of the department was not accepted by the Tribunal. Thus as a result of the Tribunal's order, the paid up capital was Rs. 5,70,000 paid up originally plus Rs. 2,20,000 men tioned above making a total of Rs. 7,90,000. The reasons for the Tribunal's finding that the sum of Rs. 2,20,000 is to be taken into account in computing paid up capital are to be found in paragraphs 17 and 18 of its order. The paid up capital of Rs. 7,90,000 arrived at above is as per the balance‑sheet as on March 31, 1956.
15. At this stage, we may mention about another point in controversy in the computation of "paid up capital", viz., that the "paid up capital" con templated is the shareholders' contribution, viz., Rs. 28,46,700, and that that figure should be taken for comparison with accumulated profits and reserves. The facts bearing on this contention appear in paragraph 4 above and may be recapitulated as follows:
The company had originally an issued share capital of Rs. 28,46,700 divid ed into 28,467 shares of Rs. 100 each. In order to wipe out the losses in the accounts, the company resolved on a reduction of capital from Rs. 28,46,700 to Rs. 5,69,300, and this reduction of capital was sanctioned by Court. The paid‑up value of each share was reduced from Rs. 1C0 to Rs. 20. There was no return of founds to the members of the company by this process of reduc tion as the reduction in capital when to wipe out the losses. Of these facts, it was contended for the company that the paid up capital must be taken as the capital originally paid up, viz., Rs. 28,56,700, with such further amounts as may have to be taken into account for this purpose under the law. The point in dispute was whether the term "paid‑up capital" covered only the capital as shown in the balance‑sheet as paid by capital for the relevant year or any other figure. For the reasons stated in paragraph 24 of its order (Annexure "B") the Tribunal held that the figures mentioned in the balance sheet for the relevant year will alone be the criterion and that the capital as originally contributed was not be taken into account. Thus, in the Tribunal's view, the paid up capital could only be Rs. 7,90,000 for purposes of apply ing section 23‑A for the year.
16. As the paid up capital thus computed, viz., Rs. 7,90,000, was less . than the accumulated profits and reserves computed of Rs. 13,04,554 (vide paragraph 13 above), the actual cost of fixed assets had to be ascertained to see whether it exceeded Rs. 13,04,554 so that the proviso will not apply. The undisputed items of fixed assets, cost the company Rs. 7,22,000. The company bad acquired goodwill by paying a sum of Rs. 5 lakhs. This was an asset in the balance‑sheet up to 1921. In 1921, to the extent of Rs. 4 lakhs, it was written off out of profits and is 1924, the balance of Rs. 1 lakh has also been written off. The relevant facts on this have already been mentioned in the paragraphs 6 and 12 above. The assessee Company s contention was that its writing off of goodwill did not destroy the existence of goodwill and that it has to be taken at an existing fixed asset. The Depart ment's contention was that it is no longer shown as an asset in the balance‑sheet and even if such an item could be considered in spite of its not being there in the accounts, there was no goodwill which could be said to survive after the huge losses incurred in1923-24. The department's conten tion was not accepted by the Tribunal and the expression "actual cost of fixed assets" found in the provision authorised, in the Tribunal's view, the cost of the asset being taken into account even though it did not appear in the balance‑sheet for the relevant year. The Department s case that the goodwill did no longer exist was not also accepted. The reasons for the Tribunal's conclusion on this point are to be found in paragraphs 28 to 30 of the Tribunal's order (Annexure "B"). The result of the Tribunal's conclusion about the fixed assets to be considered for purposes of this proviso came to Rs. 12,22,000. This was also less than the accumulated profits and reserves, viz. Rs. 13,04,554, and, therefore, application of the proviso (b) to section 23‑A was confirmed.
17. On these facts, several questions have been set out in the application for reference to cover each and every one of the items mentioned above. The scope of the dispute being given above, in detail, the only real question that arises may be formulated as follows:‑
"Whether on the facts and in the circumstances of the case and on a proper interpretation of the expressions accumulated profits and reserve', paid up capital' and actual cost of the fixed assets of the company' occurring in section 23‑A(1), proviso (b) the applicant-Company was covered by the said proviso as it stood in the relevant assessment year and whether the order under section 23‑A was rightly made on the Company "
This question, in our view, covers all the points mentioned above.
18. There are two other questions set out in the application for reference running as follows
"10. Whether the losses sustained by the assessee‑Company for the assessment years 1923‑24 and 1924‑25 should be taken into account for the purpose of determining if the distribution of Rs. 99,750 by way of dividend was reasonable "
11. Whether on the facts and in the circumstances of the case, distri bution of Rs. 99,750 by way of dividends was reasonable having regard to the smallness of profits and/or past losses and whether the Tribunal acted without evidence or misdirected itself in law holding the contrary "
19. The facts relating to the losses in 1923‑24 have already been set out in paragraph 4 above. The company has been running on better lines since March 31, 1924. It has been declaring dividends and in some years more than what it is expected to do under section 23‑A. In fact, on this basis, adjustment as contemplated by section 23‑A(6) and (7) was claimed. The Income‑tax authorities and the Tribunal took the view that such losses no longer appear, having been wiped off 1924, by the process of reduction of capital and that the loss, even if it is to be considered, was too remote as the company never felt oppressed by it and did declare large dividends subsequently, after those lean years. The assessee‑Company did not contend that the profits of the year under consideration were small. The only point made out on this aspect was that there were past losses and that the distri bution of Rs. 99,750 was reasonable having regard to the said past losses. The Tribunal did not accept this contention and held that the distribution of Rs. 99,750 was not reasonable as the loss was too remote to be taken into account and as the assessee‑Company has been declaring substantial dividends year after. We have dealt with this point in paragraph 35 of Annexure "B". It was not the case of the assessee before us that the directors had this loss in mind when they recommended distribution of Rs. 99,750. Whether there was loss or not or how far the losses, if any, affected the consideration of those distributing dividends are questions for fact findings authority. The question of the reasonableness of distribution also under these circumstances is a question of fact. Thus these questions are not such as to be referred to the High Court under section 66. We, therefore, reject the application in so far as it relates to questions Nos. 10 and 11.
20. We accordingly refer the question of law formulated in paragraph 17 above which, in our opinion, is the only question that arises out of the order of the Tribunal.
21. Both parties agree that all material facts have been correctly stated. The verbal suggestions to the draft at the instance of the assessee have been carried out in the draft. The assessee's counsel wants the applica tion for reference being included as an Annexure. It is accordingly annexed and marked Annexure "C" forming part of the case. The assessee's counsel repeated his request for referring all the questions set out in the application for reference. We see no reason to do so and we have set out our reasons for this already.
In compliance with the requisition of the High Court dated 16th Octo ber 1962, in Income‑tax Reference No. 51 of 1961 in the case of (Messrs Bombay Cycle and Motor Agency Ltd. v. Commissioner of Income‑tax, Bombay City I, Bombay we hereby draw up a supplementary statement of the case agreed to by the parties and refer it to the High Court of Judica ture at Bombay under section 66(4) of the Indian Income‑tax Act, 1922.
2. The Tribunal has already made a reference in this case which has been numbered as Income‑tax Reference No. 51 of 1961 in the High Court. By order dated October 16, 1962, one more question has been directed to be referred ‑with a supplementary' statement of the facts relating to it and the question as directed by their Lordships runs as follows:‑
"Whether on the facts and in the circumstances of the case, losses incurred by the assessee in the assessment years 1923‑24 and 1924‑25 should be taken into account for the purposes of determining the reasonableness or otherwise of the distribution of Rs. 99,750 as dividends under section 25‑A of the Indian Income‑tax Act "
3. The assessee is a company incorporated in or about 1919. Its paid up capital was Rs. 28,46,700 consisting of 28,467 shares of Rs. 100 each. The company made certain profits in the first two or three years and there after as a result of the slump 'after the First World War the fortunes of this company were affected and it suffered losses. The result of the working of the company in the year ended March 31, 1924, was a loss of Rs. 20,92,570. There was certain brought forward loss of the earlier year and the two together amounted to Rs. 28,94,310. A copy of the directors' report for the year ended March 31, 1924, and the relevant balance‑sheet, etc., as at March 31, 1924, are correctively marked Annexure "D" and form part of the case. Assessments to Income‑tax were made on the company for the account ing years ended March 31, 1923, and March, 31, 1924, by orders of the Income‑tax Officer dated August 26, 1924. As per those orders the revenue loss sustained by the company and computed as such came to Rs. 4,92,379‑1‑11 and Rs. 15,47,349‑14‑0 respectively. Copies of these two assessment orders are collectively annexed hereto. as Annexure "E" and form part of the case.
4. The loss of Rs. 23,94,310 which is the total loss sustained by the company during the year ended March 31, 1923, and March 31, 1924, was shown in the balance‑sheet as an asset. The directors considered it necessary to wipe off the said loss by reduction capital. With this object an extraordinary general meeting was held on August 18, 1924, and a resolution was passed reducing the capital of the company from the face value of Rs. 100 to Rs. 20 per share. The company took proceedings for obtaining the sanction of the High Court for such reduction of capital. The High Court sanctioned the reduction of capital. A copy of the High Court's order dated November 26, 1924, sanctioning reduction of capital is annexed hereto as Annexure "F" and form part of the case. As a result of the proceed ings for reduction of capital, the capital of the company 'came to be reduced to Rs. 5,69,340 divided into 28,467 shares of Rs. 20 each. The reduction of the capital thus amounted to Rs. 22,77,360. The loss of Rs. 23,94,310 was completely wiped out and this appears from the balance‑sheet as at March 51, 1925, wherein in the "profit and loss account" which appears on the "liabilities" side only the profit of Rs. 11,507‑8‑6 of that year is taken in account. A copy of the directors' report and the balance sheet and profit and loss account of the company for the year ending March 31, 1925, are annexed hereto as Annexure "G" and form part of the case.
5. With reference to accounting year ended March 31, 1956, at the general meeting held by the company on November 8, 1956, a sum of Rs. 99,750 was declared as and by way of dividends. This declaration was inadequate having regard to the provisions of section 23‑A and the relevant figures of income assessed, etc., have already been set out in paragraph 2 of the statement of the case submitted to the High Court. It is unnecessary to repeat those figures except to say that compared to the balance available out of the assessed income of Rs. 1,75,003 the dividend declared by the company of 99,750 was such as to attract the operation of section 23‑A according to the Income‑tax authorities. Therefore, proceedings as con templated by that provision were taken. It is not clear whether the assessee took the point before the Income‑tax Officer, that it could not declare larger dividends than Rs. 99,750 having regard to the losses sus tained by the company in the years ended March 31, 1923, and March, 31, 1924. However, this point was taken before the Appellate Assistant Com missioner who dealt with it in paragraph 8 of his order which runs as follows: ‑‑
"The only contention that remains to be considered is that having regard to losses incurred by the company in earlier years, the pay ment of a larger dividend than that declared in this case would be unreasonable. It has not been shown that the company incurred any loss in the last few years. It is only claimed that the company had incurred losses of over Rs. 20,00,000 till the year 1924 when the capital was reduced. It has not been shown to me that any loss was incurred after that year. The Income‑tax Officer has pointed out that there is no loss carried forward in the books of the company to be considered at present. It is argued on behalf of the appellant‑Company that even though the loss had been written off against the share capital, for the present purpose it should be deemed to have been carried forward in the books. This argu ment would not appear to ‑be of help to the appellant in the parti cular circumstances of this case. From the information before me I find that this loss was due to a revaluation of the fixed assets of the company and also its stock‑in‑trade in that year. A very con siderable portion of the loss on such revaluation was on account of the fixed assets. There is nothing to show how much actually incurred subsequently when any of the assets or the stock was actually disposed of. If there had been any loss at all actually incurred it has not been shown that this loss was not wiped out by subsequent profits. If the company contends that having regard to losses incurred by it in earlier years, a larger dividend than that declared would be reasonable, it should substantiate its contention by evidence. This has not been done in this case. I am, therefore unable to hold that the payment of a larger dividend‑ in this case would be unreasonable."
A further appeal to the Tribunal followed and among others this point was also debated before the Tribunal. The Tribunal considered it in para graph 35 of its order and rejected the assessee's contention for the reasons stated in the said paragraph. A copy of the order of the Tribunal has been made Annexure "B" and forms part of the case.
6. On the facts mentioned above the question as directed by Their Lordships and set out in the opening paragraph of the supplementary state ment is referred to the High Court.
N. A. Palkhivala with F. N. Kaka for Appellant.
G. N. Joshi with R. F. Joshi for Respondent.
. ‑The questions arising on this reference relate to the application of section 23‑A of the Indian Income‑tax Act to the assessee- Company. In the assessment year 1956‑57 for which the relevant accounting year was the year ended 31st March 1956, the company declared as dividend a sum of Rs. 99,750 in respect of the profits of the year ended March 31, 195(7, at the, annual general meeting held on 8th November 1956. This amount was more than 55 % but less than 60 % of the amount of Rs. 1,75,608 which was the balance available out of the assessed income after the deduction of taxes payable thereon. The Income‑tax Officer was of the opinion that the assessee‑Company was one which was required, under section 23‑A, to distribute all the balance available by way of dividend. He, therefore, gave a notice to the assessee‑Company to declare the entire amount of the balance as dividend and since the assessee‑Company failed to do so, he made an order against it under section 23‑A. Aggrieved by the said order, the assessee took an appeal to the Appellate Assistant Commissioner, but the appeal failed. It then made a second appeal to the Income‑tax Appellate Tribunal. Two contentions were raised before the Appellate Tribunal by the assessee. It was contended that the assessee‑Company did not fall in the category of the companies which had to declare 100 % balance as dividend. It was also contended that, at any rate, having regard to its past losses, the dividend declared by the assessee‑Company in the relevant accounting year could not be said to be unreasonable, and consequently the order under section 23‑A was not justified. Both there contentions were not accepted by the Appellate Tribunal which confirmed the order passed by the Income‑tax Officer and upheld in appeal by the Appellate Assistant commis sioner and dismissed the appeal of the assessee. At the instance of the assessee, the Appellate Tribunal drew up a statement of the case and referred the following question to this Court: ‑
"Whether on the facts and in the circumstances of the case and on a proper interpretation of the expressions 'accumulated profits arid reserves', paid up capital' and actual cost of the fixed assets of the company' occurring in section 23‑A(1) proviso (b) the applicant Company was covered by the said proviso as it stood in the relevant assessment year and whether the order under section 23‑A was rightly made on the company "
In the application for reference which the assessee had made, it had also prayed for two other questions for reference to this Court. The Tribunal, however, had declined to refer the said questions. On a notice of motion taken out by the assessee, this Court had directed the Tribunal to draw up a supplementary statement of the case and refer to this Court one more question as arising out of its order. The Tribunal accordingly has drawn up a supplementary statement and referred the other question which it had been directed to refer to us. That question is as follows
"Whether on the facts and in the circumstances of the case, losses incurred by the assessee in the assessment years 1923‑24 and 1924‑25 should be taken into account for the purposes of determining the reasonableness or otherwise of the distribution of Rs. 99,750 as dividends under section 23-A of the Indian Income‑tax Act "
For the purposes of this reference, we will number the original question referred to us as question No. 1 and the other question referred by the supplementary statement as question No. 2.
Section 23‑A of the Indian Income‑tax Act, which aims at preventing companies to which the provisions of the said section apply from accumu lating profits without distributing them as dividend amongst its shareholders makes it obligatory for the companies to distribute by way of dividend a certain minimum percentage of the balance of income available after deduct ing from the assessable income the taxes payable thereon. By proviso (b) to subsection (1) of the said section, as it stood at the material time, it has required that in the case of the companies of the category to which the assessee‑Company belongs, if the accumulated profits and reserves of the company (including amounts capitalised from earlier reserves) representing accumulation of past profits which have not been the subject‑matter of an order under section 23‑A(1) exceed either the aggregate of the paid up capital of the company exclusive of the capital, if any, created out of profits and gains which has not been the subject‑matter of an order under section 23‑A(l), and any loan capital, which is the property of the shareholders or the actual cost of the fixed assets of the Company, whichever is greater, the company will have to declare as dividend amongst its shareholders the entire balance available from its assessable income after deduction of the taxes payable thereon. The Income‑tax Tribunal held that the assessee- company fell within the proviso, because its accumulated profits and reserves exceeded the paid‑up capital of the company exclusive of the capital created out of its profits and gains, and they also exceeded the actual cost of the fixed. assets. According to the Tribunal, the total accumulated profits and reserves of the assessee‑company, amounted to Rs. 13,04,544, its paid up capital for the purposes of the proviso to section 23‑A(l) was Rs. 7,90,000 and the cost of its fixed assets was Rs. 12,22,000. Since the figure arrived at by the Tribunal in respect of the accumulated profits and reserves exceeded the figure of the fixed capital for the purposes of the proviso, and the figure for the value of the fixed assets, the Tribunal held that the assessee Company fell within the proviso and was obliged to declare the entire amount of the balance by way of dividend. Since it had not done so, the Tribunal held that the Income‑tax Officer was entitled to pass an order under section 23‑A, as he had done. On the other contention raised by the assessee, namely, that in view of its past losses the dividend declared by it could not be regarded as unreasonable and, therefore, the order under section 23‑A was not justified, the Tribunal took the view that the past losses, which were the losses of the years 1923‑24 and 1924‑25, were too remote to be taken into consideration. It also held that since the assessee had declared substantial dividends in past years and had at times even declared dividends in excess of what it was required to do under the provisions of section 23‑A it was apparent that the Company was not oppressed by these losses so as to be reluctant to declare dividend, and that was also a circumstance which showed that the losses were too remote to be taken into account. The Tribunal was also further of the view that losses having been adjusted against capital by reduction of capital no longer survived as commercial losses and what was required to be taken into consideration under section 23‑A were commercial losses. Having regard to all these circumstances, the Tribunal declined to take the said losses into account for considering the question whether in view thereof, it would have teen unreasonable to expect the company to declare a larger dividend than what it had actually done. It accordingly concluded that the order passed by the Income‑tax Officer under section 23‑A was perfectly legal and proper and dismissed the assessee's appeal.
Mr. Palkhivala, the learned counsel, who appears for the assessee, has argued before us that the view taken by the Appellate Tribunal that the assessee‑Company falls within the proviso to section 23‑A(1) is erroneous. According to the learned counsel, the conclusion of the Tribunal that the paid up capital of the assessee‑Company for the purposes of the proviso is Rs. 7,90,000 is erroneous. According to him, the paid up capital of the company for the purposes of the proviso is Rs. 28,46,700 which is the amount actually paid by the shareholders for the shares of the company allotted to them. As to the figure arrived at by the Tribunal in respect of the accumulated profits arid reserves at Rs. 13,04,554, he argues that three of the items which the Tribunal has included in the computation of the said figure do not really belong to the category of accumulated profits and reserves and must be excluded therefrom. If these three items are excluded, the figure arrived at for the accumulated profits and reserves will fall much below the value of the fixed assets as determined by the Tribunal. As to the value of the fixed assets, he has no complaint to make with regard to the figure arrived at by the Tribunal at Rs. 12,22,000.
Now, in arriving at the determination of the paid up capital of the company for the purposes of the proviso to section 23‑A(1), the Tribunal has taken the paid up capital as shown in the balance‑sheet of the company as at 31st March, 1964. In the said balance‑sheet, the paid up capital has been shown as 28,500 share of Rs. 20 each fully paid up in cash and 28,500 shares of Rs. 20 each issued as fully paid up without payment being received in cash, thus amounting to a total of Rs. 11,40,000. Out of this amount of Rs..11,40,000, bonus shares to the extent of Rs. 5,70,000 were not paid for by the shareholders, but they were issued to them as fully paid up. This amount of Rs. 5,70,000 was made 'up of Rs. 3,50,000 from the accu mulated revenue profits and Rs.2,20,000 from the capital profits. Since the paid up capital of the company, which was required to be considered for the purposes of the proviso, was paid up capital exclusive of the capital, if any, created out of the commercial profits and gains, the amount of Rs.3,50,000, which belonged to the category of commercial profits and gains, was excluded from the total paid up capital of Rs. 11,40,000 and the balance of Rs. 7,90,000 was taken to be the paid up‑ capital of the company for the purposes of the proviso.
Mr. Palkhivala has argued that the expression "paid up capital of the company" as used in the proviso does not mean the paid up capital as shown in the balance‑sheet of the company at a given time, but the actual payment made by the shareholders to the company in respect of the shares which were allotted to them by the company and if this is the true meaning of the expression as used in the said proviso, it must be held that the paid up capital of the assessee‑Company was Rs. 28,46,700 which was the amount paid by its shareholders to the company on the shares allotted to them by the company. In‑ order to appreciate this argument of Mr. Palkhivala it is necessary to state a sew facts. The assessee‑Company was incorporated in the year 1919. Its paid up capital at its inception was Rs. 21,46,700, consisting of capital issued and paid up on 28,467 Shares of Rs. 100 each. The company after its incorporation in the year 1919 made profits for 2 or 3 years thereafter and then during the slump following the First World War, suffered heavy losses in the years 1923 and 1924. The total amount of the losses which the company had suffered during those years came to Rs. 23.94,310. It wiped out its live losses by reducing its paid up capital from Rs. 28,46,700 to Rs. 5,69,340 and adjusting the reduction in capital, against the losses. After this reduction of capital, the company's paid up capital stood at Rs. 5,69,340 made up of 28,467 fully paid up shares of Rs. 20 each. It then issued a few more forfeited shares and brought up the number of shares to 28,500 and thus the company's capital thereafter stood at Rs. 5,70,000 made up of 28,500 shares of Its. 20 each fully paid up. In subsequent years, the company's state of affairs improved and in the year 1948, it issued 28,500 bonus shares of Rs. 20 each fully paid up to share holders. After the issue of the said bonus shares, the paid up capital of the company stood at Rs. 11,40,000 made up of 28,500 shares of Rs. 20 each fully paid up in cash and 28,500 shares of Rs. 20 each issued as fully paid up without payment being received in cash.
Now, Mr. Palkhivala argues that the paid up capital of the company as contemplated under the proviso to section 23‑A(1) is the actual payment received by the company from the shareholders in respect of the shares issued to them. The company had issued to its shareholders 28,467 shares and the shareholders of the company had paid on the said shares Rs. 28,46,700 to the company; the paid up capital, therefore, was Rs. 28,46,700. What is required to be considered for the purposes of the proviso, according to the learned counsel, is not what is shown as paid up capital in the balance‑sheet of the company, but what in. reality is the paid up capita: of the company, namely, the amount which the shareholders have paid for the shares issued to them. Mr. Palkhivala says that the expression "paid up capital" is not defined in the Companies Act or in the Income tax Act, nor is it a term of art. It will, therefore, be possible to take the ordinary meaning of the expression as would be appropriate in the context of the provision in which it appears. He has referred us to Jowitt's Dictionary of English Law where "paid up capital" has been given the meaning that it is the amount of money actually paid of deemed to have been paid on the shares actually allotted. According to the learned counsel, therefore the meaning, which he seeks to give to that expression, namely, that it is the money actually paid up by the shareholders for the shares allotted to them, is a reasonable meaning which would be given to it. He argues that having regard to the object of the provision, the indications given by the provision itself and the effect which the provision has, the only proper meaning which can be given to the expression "paid up capital of the company" as occurring in the proviso to section 23‑A(1), is the meaning which he wants to suggest. The object of the provision of section 23‑A is to require the companies, who are in a position to distribute dividend, to do so without accumulating profits and keeping them undistributed. Where a company has made profits and has available to it a surplus from the profits, after payment of the taxes payable thereon, for distribution amongst its shareholders, the Legislature has required the company to distribute at least 60% of the surplus by way of dividend amongst its shareholders. In the case of companies which stand on solid financial basis and have no reason whatsoever to augment their reserves or accumulated profits, the Legislature has required such companies to distribute the entire 100 % of the available surplus by way of dividend. The criterion fixed under the proviso is that where the accumulated profits or reserves of the company more than match the paid up capital or the loan capital brought by the shareholders or the value of the fixed assets of the company, the company should distribute the entire profits as dividend without keeping back any part thereof by way of reserve etc. What is intended by the Legislature, according to the learned counsel, is that where the accumulated profits or reserves of the company exceed the total investment of the shareholders of the company, the company has no business to keep back any part of the profits available for distribution. In view of this intention, what must be seen is, what is the investment of the shareholders in the company and for that purpose, what must be considered is what they have actually paid towards the shares and not what merely stands as paid by them in the balance sheet of the company. That in fixing the criterion for the companies which should distribute the entire amount of profit by way of dividend, regard is had for the total investments made by the shareholders in the company, is, according to the learned counsel, apparent from the provision itself. The aggregate amount against which accumulated profits and reserves are required to be matched, are the paid up capital exclusive of such part of it which has been created out of accumulated profits and gains and the loan capital brought in by the shareholders. The capital, exclusive of that part which is made up of the profits and gains is the money brought in by the shareholders byway of payment for the shares issued to them. Similarly, the loan capital which is referred to in the said provision is the money which has been brought in by the shareholders. The provision of the statute therefore has in mind the total investment of the shareholders in the company. The expression "paid up capital of the company", therefore, in view of these indications, can quite reasonably be taken to be that investment of the shareholders which they have made in the company for the shares issued to them. He has further argued that the expression "paid up capital of the company" as contained in this proviso has no reference to the balance‑sheet of the company, is also indicated by the circumstance that the other matters referred to in this proviso also have no reference to the balance‑sheet. Thus, he says that the loan capital, which is the property of the shareholders as referred to in this proviso, is not an item, which is to be found in the balance‑sheet, nor the actual cost of the fixed assets is to be obtained from the balance‑sheet. The learned counsel, there fore, has argued that the expression "paid up capital of the company" as used in this proviso has relation to what in reality is the paid up capital and no relation as to what is stated as the paid‑tip capital in the balance sheet of the company. Another argument advanced by the learned counsel to support his contention that the proper interpretation of the expression "paid up capital of the Company" as used in this proviso must be the pay ment actually made by the shareholders in respect of the shares issued to them, is the effect of the proviso. The effect of the proviso, says the learned counsel, is that of the accumulated profits and reserves exceed the paid up capital as ascertained under this proviso, the company is obliged to distribute 100 % of the available surplus by way of dividend. Thus, a company like the assessee‑Company who has got rid of the heavy losses suffered by it by a reduction of its capital will sooner fall within the mischief of this proviso than a company which keeps its losses unadjusted against its capital and maintains its capital without reduction. It could not have been intended by the Legislature, says the learned counsel, that a company which has allowed its capital to be severely crippled by adjusting it against the losses suffered by it, should without having any opportunity to recoup its financial strength, go on distributing the entire surplus income by way of dividend. Having regard to the object of the provision, which is to require the companies who are in a really sound financial position, to distribute its profits by way of dividend and having regard to the effect which this provision would have in making even companies existing precariously to the distribute the entire profit as dividend, the learned counsel says that, it would be reasonable, proper and fair to interpret the expression "paid up capital of the company" as used under the proviso as what in reality is the money paid by the shareholders on the share allotted to them.
We have given our anxious consideration to these arguments which have been advanced by the learned counsel for the assessee. We are, however, not inclined to give the expression the meaning which has been contended for it by Mr. Palkhivala. The expression "paid up capital of the company", though not defined in the Companies Act or in the Income‑tax Act, is an expression well‑known to people dealing with companies and their affairs. There can be no doubt whatsoever that for considering what is the "paid‑up capital of the company" an ordinary person will have recourse to the balance‑sheet of the company. The ordinary meaning which any one will associate to the expression "paid‑up capital of the company" is what he would find from the balance‑sheet of the company as held by the company at a given time as its paid‑up capital. The question to be considered is whether the expression "paid‑up capital of the company" as used in the proviso has this ordinary meaning which a person familiar with the companies and its affairs will give it or some other meaning which the expression is capable of having In the first place, the expression used in the provision is "the paid up capital of the company". The paid up capital of the company which this proviso requires to be considered is the paid up capital of the company at the time when the application of the provisions of section 23‑A is required to be made to the company. Now, it may be that a company at its inception may start with a larger paid up capital. The Companies Act contains provisions whereby the company is allowed to reduce its capital. If the company avails of those provisions and reduces its capital, for subsequent times, the company's capital will not be the original capital, but the reduced capital, and it will not be possible to say with reference to any point subsequent to the reduction that the paid up capital of the company is what initially it was before the reduction. Therefore, it appears to us difficult to accept Mr. Palkhivala's contention that by the expression "paid tip capital of the company" as used .in the proviso is meant something other than what actually is the paid up capital of the company as per its balance‑sheet at the given point of time. As regards the argument of Mr. Palkhivala that the intention of the Legislature in enacting the provision would indicate that it contemplated by the expres sion "the paid up capital of the company" used by it, the money actually paid by the shareholders for the shares issued to them, we do not think that the said argument is also sound. The intention of the Legislature is no doubt to specify a certain criterion for judging the companies which should be expected to distribute 100 % of its available profits by way of dividend and the criterion is fixed on the basis that if the accumulated profits and reserves exceed the paid‑up capital of the company as specified and the loan capital brought in by the shareholders, or the cost of the fixed assets, the company should be regarded as capable of distributing the entire income available to it by way of dividend. But it seems to us that the criterion to be applied is to the company's position as it appears on the balance‑sheet of the company the rule which has been laid down is for general application and has not been laid down with reference to exceptional cases which may come up, Thus, for instance, a company which appears on its balance‑sheet to be in a sound financial position inasmuch as the accumulated profits and reserve exceed the paid up capital and the loan capital, may in fact and in reality not be in a sound financial position by reason of having done away with a part of the paid up capital for wiping off its losses. To deal with such excep tional cases, provision has been made in the section that simply because the provisions or section 23‑A are attracted an order need not be passed under the said section, if there are circumstances justifying the non‑making of such an order, namely, past losses or small profits. The argument, there fore, that view of the intention of the Legislature in enacting the provision the expression "paid up capital of the company" must be given a different meaning than what may ordinarily be understood by it by a person conver sant with the company matters, does not appeal to us. We may also point out that it appears to us that the provision itself indicates that the expres sion used by the Legislature is intended to be understood in the ordinary sense in which it will be understood in company matters. What the provi sion says is that the paid up capital of the company to be considered for this purpose is the paid up capital exclusive of the capital created out of the profits and gains. In other words, the part of the paid up capital of the company which is to be taken into account is that which does not include capital created out of accumulated profits. Now, the capital created out of the accumulated profits could not possibly have come out of the pockets of the shareholders. It however forms a part of the paid‑up capital of the company and is excluded under the latter part of the provision. Similarly, capital created out of the capitalised profits would also form part of the paid up capital of the company which is required to be considered for the purpose of the proviso. .It is thus clear that the expression "paid‑up capital of the company" as used in the proviso is not restricted in its operation to mean only the; capital made up of the money paid by the shareholders on the shares allotted to them but includes all paid up capital formed in whatever way it is possible for the company to form it. This, in our opinion, is sufficient to negative Mr. Palkhivala's contention that by the expression "paid‑up capital of the company" it meant only the money which the shareholders have paid towards the shares allotted to them. It is true, as Mr. Palkhivala has contended, that in fixing the criterion for the companies which should be required to distribute the entire 100% of the surplus of the available income for distribution, regard is had to the amounts which are invested by the shareholders in the company. It is for that reason that the provision requires to match the accumulated profits and reserves against the paid‑up capital of the company (exclusive of the capital created out of accumulated profits) and the loan capital brought in. by the shareholders of the company. But this investment of the shareholders in the company, to which regard is required to be had under the proviso, appears to be such as is indicated by the state of company's affairs on its balance‑sheet at the material time. The amount against which the accumulated profits and reserves are required to be matched is the amount which stands invested as the paid‑up capital of the company at the given point of time and the loan capital of the shareholders, if any. If the shareholders in the past had invested a larger, amount in the company and the parts of the said invest ments have been eaten up by the losses suffered by the company, what stands as invested in the paid up capital of the company after such extin guishment of a part of it is what remains as the paid‑up capital of the company. The provision as it is worded has reference to the paid‑ up capital of the company and not the money originally invested by the shareholders in the capital of the company. The paid up capital of the company at any given time must, in our opinion, be actually what the company holds as its paid up capital at the said point of time. Mr. Palkhivala's argument, that the expression "paid up capital of the company" is not required to be considered with reference to what is contained in the balance‑sheet of the company, because other matters referred to in the proviso have also no reference to the balance‑sheet, namely, the loan capital or the actual cost of the fixed assets, does not appeal to us. The term "loan capital", as pointed out by Palmer in his Company Law, denotes the debentures and debenture stock issued by the company. It may be that it may not find a reference in the balance‑sheet as "loan capital", but it is not, therefore, that it has no reference to the balance‑sheet because it may be found mentioned there as debenture or debenture stock. The actual cost of the fixed assets, no doubt may not appear in the balance‑sheet, but the provision has required its costs to be ascertained because it is against the actual cost of the fixed assets that the position that the accumulated profits and reserves are required to be judged in order to determine whether the company should be considered to be able to distribute the whole of its available income as dividend. The circumstance that certain other items referred to in the provision are not to be found in the balance‑sheet cannot, in our opinion, furnish an argument that the balance‑sheet is not intended to be looked at even for such items as can be properly found from it. The further argument of Mr. Palkhivala is that having regard to the object of the provision and the effect it would have, it would be reasonable to construe the expression "paid up capital of the company" not as paid up capital as found in the balance‑sheet, but as the actual moneys paid by the shareholders to the company on the issue of shares to them. This said argument also does not appeal to us. It must be remembered that we are concerned here with the provision of a taxing statute. It is often said that so far as a taxing statute is concerned, there is no logic, nor any equity. What has got to be considered is what the provision is and whether it applies or does not apply. The rules framed under section 23‑A, like several other rules under the Income‑tax Act, are arbitrary rules. If an assessee falls within the purview of the rules, the rule will apply; if it does not fall, the rule will not apply. The circumstance that an assessee by adopting one course of method will avoid a rule and by resorting to another method will come within its purview has no bearing on the interpretation of the rule. Taking the main provision of section 23‑A itself a company which has a surplus available from its profits after deduction of the taxes payable thereon, is required to distribute a certain percentage of the said surplus. Now, if a company having suffered losses in one year, instead of carrying forward those losses gets rid of them by adjusting them against capital, and in the next year makes profits and has a balance available for distribution, the provision of section 23‑A will be attracted to such a company. Another company similarly situated, which, instead of adjusting its losses against its loan capital, carries it forward and makes profit in the next year, will not in view of its existing losses be required to distribute the dividend. That, however, is the result of the two companies having adopted one mode or the other. The provisions are attracted in one case and they are not attracted in the other case. The circumstance, however, will not permit an attempt to construe the provision in some different manner so as to avoid this apparent anomalous result. As in the case of main provision so also in the cases governed by the proviso, the same would be the position. The companies which adopt the process of reduction of capital to get rid of losses will have their paid up capital sooner matched by the accumulated profits and reserves than the companies who have not reduced the capital and allowed the losses to persist. But the companies are not obliged to follow one way or the other. It is true that some will be affected by the rule, while others will not be, if they follow a different procedure. That, however, in our opinion, is no argument for holding that the rule has, therefore, to be constru ed in a manner different from what its language provides. Id our opinion, therefore, Mr. Palkhivala's contention that the paid up capital of the company for the purposes of section 23‑A, proviso (b) must be regarded as Rs. 28,46,790 cannot be accepted. As we have already pointed out earlier, the Tribunal has ascertained it at Rs. 7,90,000 composed of Rs. 5,70,000 which is shown to have been actually paid in cash by the shareholders on the issue of 28,500 shares of Rs. 20 each to them, and the amount of Rs. 2,20,000 which has gone out of the capital profits to make up the issue of 28,500 bonus shares of Rs. 20 each to the shareholders without receiving value in cash for them. In our opinion, the said ascertainment of the paid up capital exclusive of the capital made by the Tribunal is correct. The paid up capital of the company is in all Rs. 11,40,000. Rs. 5,70,000 out of this amount are of the shares paid in cash by the shareholders. The remaining amount of Rs. 5,70,000 is of the bonus share issued without receiving payment in cash. Of the amount of Rs. 5,70,000 for the bonus shares, the amount of Rs. 3,50,000 is admittedly out of the accumulated Profits. Under the proviso that amount has to be excluded from the paid up capital. Excluding this amount of Rs. 3,50,000 from the total Of Rs. 11,40,000 the balance is Rs. 7,90,000, which is the paid up capital of the company exclusive of the capital created out of the profits and gains.
With regard to the figure arrived at by the Tribunal for accumulated Profits and reserves at Rs. 13,04,547, Mr. Palkhivala has taken exception 10 three items, namely, an item of Rs. 4,00,000 which is the profit adjusted by the company in writing off its goodwill, an item of Rs. 1, 26,297 which is shown in the balance‑sheet as investment depreciation reserve, and an item of Rs. 78,500 which is shown in the balance‑sheet as gratuity fund. Accord ing to Mr. Palkhivala, all these three items do not belong to the category of accumulated profits and reserves and if all three of them are taken away or even if any of the first or second is taken away, the figure of the accumula ted profits and reserves will fall below the figure of Rs. 12,22,000 which the 'tribunal has determined as the actual cost of the fixed assets of the company and with which figure he has no quarrel to raise. Now, coming to the first of these items, namely, the amount of Rs. 4,00,000 adjusted against the good will of the company, it may be stated that the company had purchased the goodwill initially at a sum of Rs. 5,00,000. As we have already stated, the company after it started its career made profits during the first 2 or 3 years. During these years of profits, it wrote off its goodwill to the extent of Rs. 4,00,000 and adjusted it against its profits. In the year 1924, which was a year of heavy losses for the company, it wrote off the remaining Rs. 1,00,000 value of the goodwill and adjusted it by increasing its losses to that extent. After the goodwill was thus completely written off, it ceased to be shown as an asset of the company in its balance‑sheet. Now, in determin ing the actual cost of the fixed assets of the company, the Tribunal found that the actual cost of the other fixed assets of the company was Rs. 7.22,000. The goodwill was, no doubt, an asset of the company which it had purchased for the actual cost of Rs.5,00,000. Although as a result of having been written off it bad ceased to appear as an asset in the balance‑sheet, the Tri bunal rightly held that its value as an asset has not ceased to exist. Though non‑existent in the balance‑sheet, it was an asset of the company and since the actual cost of the fixed assets of the company were required to be taken into consideration, a sum of Rs. 5,00,000 was required to be added in arriving at the actual cost of the fixed assets of the company. It, ‑therefore, determined the actual cost of the fixed assets of the company at Rs. 12,22,000. It was contended before the Tribunal that if the asset, which, had been written off in the balance‑sheet of the company by having been adjusted against a part of the profits of the company, was to be taken as an existing fixed asset of the company the amount of the profits which has been adjusted in writing it off in the balance‑sheet must also be taken as actually existing as a part of the accumulated profits or reserves. The accumulated profits and reserves, there fore, must be increased by a corresponding amount. Now, as we have already pointed out, only Rs. 4,00,000 out of the value of the goodwill were adjusted against the profits. The remaining amount of Rs. 1,00,000 was adjusted by increasing the loss. The 7ribunal accepted this argument which was advanced before it and took the view that the amount of Rs. 4,00,000, out of the amount of Rs. 5,00,000 for the value of the goodwill, which was adjusted against the profits of the company, must be added to be accumulated profits and reserves since the written off goodwill was treated as a fixed asset of the company and its cost included in the determination of the actual cost of the fixed assets.
Now. Mr. Palkhivala argues that the profits adjusted in writing off the goodwill cannot survive as accumulated profits or as reserves after the adjust ment. The Tribunal, as a matter of fact, regarded this amount of Rs. 4,00,000 as a reserve to be added to the reserve of the company. Now, it can straightway be said that this amount of Rs. 4,00,000 cannot be treated as reserve at all. As has been pointed out by the Supreme Court in Commis sioner of Income‑tax v. Century Spinning & Manufacturing Co. Ltd. (1953) 24 I T R 499=1954 S C R 203 that a reserve whether a general reserve or a special reserve is an amount set apart for a general or special purpose as the case may be. A sum which has been already adjusted cannot be regarded as a sum earmarked or kept aside to be utilised for a certain specific or general purpose. It is however, argued that though the amounts of Rs. 4,00,000 may not qualify as reserve it could still be regarded as a part of the accumulated profits. Mr. Joshi for the revenue has relied in this connection on an English case Stapley v. Read Brothers Ltd. (1924) 2 Ch. 1. In that case, a company had applied its profits in writing off the value of the goodwill instead of carrying them to a goodwill depreciation reserve fund. Subsequently, it brought back the goodwill as an asset giving it a certain value and to the extent of that value released the profits which it had applied in writing off the goodwill for distribution as dividend. Against this conduct of the company, an action was brought by a shareholder con tending that the company had no right to do so. It was contended that the profits having been applied for writing off the goodwill had been turned into capital and the company had no right thereafter to convert these profits into revenue profits for distribution. The argument was negatived on the ground that although the profits were turned into capital, they had not finally and irrevocably been capitalised so as to disentitle the company from afterwards restoring them to its reserve and from dealing with them as profits. It was held that the action taken by the company, therefore, was not illegal. Rely ing on the said decision, Mr. Joshi has argued that although an amount of Rs. 4,00,000 out of the accumulated profits had been applied for writing off the goodwill, the said amount had not been irrevocably capitalised and, there fore, if the written off asset of the goodwill was said to be still existent having a value, the part of the profits which went towards the writing off of the goodwill must again be regarded as forming part of the accumulated revenue profits. In our opinion, the argument advanced by the learned counsel can not be sustained. What the case relied upon by Mr. Joshi shows is that the company, if it wanted to bring back the goodwill as an asset on the balance sheet of the company, would have been entitled to add the amount of profits applied in writing off the goodwill back to its accumulated profits or reserves, but it would be for the company to do so. If the company does not choose to do so and keeps the profits applied in writing off the goodwill as so applied, it will not be possible for any one else to regard the said profits as still forming part of the accumulated profits or reserves. What the provision of section 23‑A (1) proviso (b) has asked the Income‑tax authorities to deter mine is to find out the accumulated profits and reserves which exist as accu mulated profits and reserves. What is adjusted out of the profits cannot be regarded as still forming part of either the accumulated profits or reserves. It is not contended that the adjustment of the profits against the writing off of goodwill was in any way irregular or that it was an attempt at camouflag ing or concealing the profit. In our opinion, therefore, the Tribunal was wrong in adding the amount of Rs. 4,00,000 in computing the total amount of accumulated profits and reserves simply because the goodwill has been regard ed a: a fixed asset in calculating the value of the fixed assets. Coming to the next item of Rs. 1,26,297 which has been shown as the investment dep reciation reserve, the argument of Mr. Palkhivala is that at any rate to the extent of Rs. 83,497 out of this amount, the item cannot be regarded as part of the reserve. His argument in that connection is that the book value of the investment is Rs. 2,34,300, while the market value of the same at the material time is Rs. 1,50,803. There has been, therefore, an actual depreciation in the value of the investment to the extent of Rs. 83,497 and to the extent of this actual depreciation, the amount of Rs. 1,26,297 cannot be regarded as a reserve, but only to the extent of the excess of this amount over Rs. 83,497. We do not think that Mr. Palkhivala is right in the submission which he has made. The reserve, as we have pointed out earlier, is a sum kept apart to be used either for a general or a specific purpose in future. If any part of the said amount is actually employed for any of the purposes for which it is set apart, it ceases to be a part of the reserve, but so long as that is not done, it continues to be a part of this reserve. It is undisputed that no part of this reserve has been utilised towards the actual depreciation suffered in the in vestment. The same, therefore, to the entire extent continues to be a reserve and has been rightly treated as such by the Tribunal.
We then come to the last item, namely, the amount of Rs. 78,500 specified in the balance‑sheet as the gratuity fund. Now, liability for the gratuity has been thrown on the company by the awards made by the labour Court on 16th August 1949. In view of the said liability created under this award, the asses see‑Company has set apart a gratuity fund to the extent of Rs. 78,500 which, it appears, it has carried on for a few years in its balance‑sheets from year to year. Mr. Palkhivala argues that this amount of Rs. 78,000 neither belongs to the category of accumulated profits or reserves, but is really a provision for a liability which has to be provided for. 'The Tribunal regarded it as a reserve like any other reserve and held that it was liable to be included in the cate gory of accumulated profits and reserves. Mr. Palkhivala has referred to us a decision of this Court in Greaves Cotton & Crompton Pakistan Ltd. v. Commissioner of Income‑tax (1963) 48 I T R 20 where this Court has taken the view that a provision made in respect of liability which has been imposed by an award could not be regarded as a provision in the nature of a reserve fund. It was contended in that case that although a liability was created by the award to pay gratuity to the employees, no amount by way of gratuity had become immediately pay able. It was also pointed out that the gratuity would become payable to the workers when the worker would retire or would cease to work on account of disability or death. In some cases the employee would not even be entitled to a gratuity. Therefore, it was not possible to ascertain what would become payable is gratuity and under the circumstances, the amount which has been set apart to make provision for gratuity required to be paid in future could not be anything but a reserve. This Court, however, was not inclined to accept the submission that the provision made for gratuity could be regarded as a reserve. What it pointed out was that a reserve was a fund set apart to meet a future expenditure or a liability which would fall at a future time. Where a liability has actually fallen though the quantum of the liability has not yet been determined, a provision made to meet the present liability is not a provision by way of a reserve. In our opinion, in view of the observations in the said decision, the amount of Rs. 78,500 appearing as gratuity fund can not be regarded as an item of accumulated profits and reserves. Even ex cluding the amount of Rs. 4,00,000 from the figure arrived at by the Tribunal towards the accumulated profits and reserves the said amount will be far less than the amount of Rs. 12,22,000 which has been determined by the Tribunal as the actual cost of the fixed assets of the company. That being the position, the assessee‑Company cannot, in our opinion, fall within the proviso to section 23‑A (1964) 51 I T R 683 of the Indian Income‑tax Act, and the order passed by the income‑tax Officer under section 23‑A against the company on the basis that it falls within the proviso cannot, therefore, be sustained.
This would really dispose of the reference because in the view that we have taken, the second question will not require to be answered. Since, however, arguments have been advanced on that question, we will briefly proceed to discus the same. Now, what the Tribunal has done is, as we have already pointed out in stating the facts, that it has not taken into account the past losses because in its opinion by reason of their being not commercial losses and by the reason of their having been adjusted against capital by reduction of capital and by the reason of the company's conduct in declaring substantial dividends in subsequent years, the said losses are not required to be taken into consideration. Now, in Jubilee Mills Ltd v. Commis sioner of Income‑tax (1964) 51 I T R 683, we have held that losses incurred by a company in ear lier years do not cease to be losses which have to be considered under sec tion 23‑A of the Income‑tax Act, 1922, in determining whether it would have been unreasonable for the company to have declared a higher dividend merely because such losses have been adjusted against the capital of the company and the company has been re‑constructed with reduced capital. We have held in that case that the view that such losses disappear altogether as losses on the re‑construction of the company and cease to have any bearing thereafter on the question of reasonableness of the distribution of dividends in subsequent years is not correct. The reason given, therefore, by the Tribunal that because the losses have ceased to be commercial losses they are not required to be taken into consideration cannot be considered as a good reason. We do not also agree with the Tribunal that because the losses have occurred not in recent years, but at somewhat distant years, is any good reason for regarding the losses as irrelevant. The mere circumstance that a loss has occurred only in recent years does not by itself qualify it to be taken into consideration. Similarly, the mere circumstance that a loss has occurred not in the imme diate past does not disqualify it from being taken into consideration. The effect of the loss may continue for a number of years. On the other hand, the losses may be comparatively insignificant so as to lose all their significance with a short time. A mere circumstance, therefore, that the loss has occurred some years ago is not by itself sufficient to throw it out of consideration. Further reason given by the Tribunal that because the company has distri buted dividends it must be taken not to have been oppressed by the loss sustained by it and, therefore, the loss ceases to have relevance in considering the ability of the company to distribute dividends, is not again a good and sound reason. In our opinion, therefore, the view taken by the Tribunal that the past losses of the assessee‑Company are not required to be taken into con sideration in considering whether an order under section 23A is justified or not, cannot be regarded as correct. The result, therefore, is that our answer to the first question is that the assessee‑Company is not covered by section 23‑A (1964) 51 I T R 683 proviso (b) of the Income‑tax Act as it stood at the material time and that the order made by the Income‑tax Officer under section 23‑A against the company was not rightly made. Our answer to the second ques tion is in the affirmative. The Department will pay costs of the assessee.
Reference answered accordingly.
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