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Income‑tax Reference No. 44 of 1958, decided on 17th June 1959.
S. 23‑A‑Company‑Undistri buted pr‑fits‑Order for distribution‑ Exception‑Smallness of profits‑Ascertainment of commercial profits‑Method.
In order that the Income‑tax Officer may make an order under section 23‑A of the Income‑tax Act, declaring that the undistributed profits of a company shall be deemed to be distributed, the first condition which must be satisfied is that the profits and gains distributed by the company as dividend amongst the share holders are less than 60 per cent. of the assessable income as reduced by the amount of income‑tax and super‑tax payable in respect thereof. Even if this condition is satisfied, it is the duty of the Income‑tax Officer further to ascertain whether, having regard to the smallness of the "profits made", it would be unreasonable to distribute a dividend larger than the one declared. By the expression "profits made", the section does not refer to the assessable profits but to the net commercial profits which could not be distributed by the company. The distributable commercial profits are arrived at by deducting from the gross commercial profits, neither the tax which is appropriate to the gross commercial profits, nor the total amount of tax which may ultimately be assessed for that year, but that amount of tax which the company could have reasonably anticipated as likely to be imposed by the income‑tax authorities, having regard to its transactions at the date on which the dividend was declared at the general meeting.
Commissioner of Income‑tax v. F. L. Smidth & Co. (Bombay) Ltd. (1959) 35 I T R 183 fol.
By this application, the assessee requires the Appellate Tribunal to refer to the High Court three questions of law, which are said to arise out of the Tribunal's order in I. T. A. No. 6728 of 1956‑57. 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 Income‑tax Act.
2. The assessee is a private limited company. The question which fell to be determined' was whether the Income‑tax Officer was right in passing an order under section 23‑A of the Income tax Act. It rested on the ascertainment of profit available for declaring the dividend. The Income‑tax Officer computed the assessee's profit for the purpose of section 23‑A in the manner described in the order of the Tribunal at Rs. 1,37,693. The total dividend declared by the assessee amounted to Rs. 12,800 (Rs. 100 per share of Rs. 250 each). The total tax levied by the Income‑tax Officer for the assessment year under reference amounted to Rs. 49,689.
3. The assessee raised a number of objections to the computation made by the Income‑tax Officer. The Tribunal agreed with some of them. In two cases the contention of the Department was rejected. One of the questions which arose was as to the provision for bonus to be taken into account for the purposes of section 23A. The assessee had been providing bonus for its employees in the past in round figures from year to year. After making the payment of bonus, there was always a surplus left in that account. The accumulated surplus in respect of the provision made for the assessment years 1947‑48, 1948‑49 and 1949‑50 amounted to Rs. 20,432‑14‑3. In the year of account, the assessee had provided a sum of Rs. 1 lakh. In the preceding years, the bonus had been paid on the basis of three months' salary. It should have been a little over Rs. 80,000. The matter had been referred to the Labour Tribunal on March 28, 1950. The labourers demanded more than Rs. 1 lakh. The award came later on February 28, 1951. The award was very beneficial to the assessee. Whereas it itself had provided a sum of Rs. 1 lakh, the award allowed the employees a sum of Rs. 55,459. The assessee contended that for the purpose of ascertaining the profits for the purpose of application of section 23A, the Income‑tax authorities should take into account the liability provided by the assessee and not the actual liability ascertained as a result of an award by the Labour Tribunal, on a later date. In other words, the assessee wanted that the amount available for dividend should be ascertained on the basis of the position as it existed at the time of the declaration of the dividend. The Tribunal agreed with that view, but it held that the assessee should adopt a consistent method in respect of the payment of bonus i.e., allowance should be made on the basis of the provision made, but the excess of the provision earlier should be brought into account when the liability was ascertained. Whereas the Tribunal allowed the assessee to claim Rs. 1 lakh on account of the provision made in the year of account, it directed that the excess provision made in the earlier years should be treated as the profit of the year. In effect the Tribunal allowed Rs. 1 lakh minus Rs. 20,433 as the provision of the year of account. The assessee is very happy with the decision of the Tribunal in respect of the provision of Rs. 1 lakh. As regards the sum of Rs. 20,000 odd, it is stated this could not be taken to be the profits of the year. This is an inconsistent stand taken by the assessee. The two items cannot be segregated. If the assessees stand was accepted, only the liability of the year of account, i.e., Rs. 55,459, should have been taken into account. It appears there is some misapprehension in the mind of the assessee as to the order of the Tribunal. As we have stated hereinbefore in effect the Tribunal only allowed Rs. 1 lakh minus Rs. 20,433.
4. The second question on which we are asked to make a reference relates to the tax liability to be deducted under section 23‑A. The assessee says that the Department should take the actual tax relating to the assessment year into account. The Tribunal held that the assessee should take a consistent stand. If it wants to claim that for the purpose of ascertaining the amount available for dividend it should be allowed to deduct tax as ascertained by the Income‑tax Officer at a later date, it must take the income also as assessed by the Income‑tax Officer. If, on the other hand, it wants to ascertain its income as at the time when the dividend was declared, it has to take into account the tax liability on that basis. As the Tribunal had allowed the assessee the provi sion made for unascertained liability before arriving at the profits available for dividend, the tax liability has to be computed on the same basis. The assessee cannot have it both ways. This question, therefore, is also interlinked with the ascertainment of the profits available for dividend.
5. In the opinion of the Tribunal if the assessable profits were taken into account, the deduction of tax should also be on that basis. If, on the other hand, the income was to be computed by taking into account certain aspects as at the time of declaration of dividend, the tax liability on the income so computed should only be allowed to be deducted.
6. A copy of the order of the Tribunal giving detailed reasons and the calculations is annexure A' and forms part of the case.
7. The question of law which arises is;
"Whether on the facts and circumstances of the case, the Income‑tax Officer was right in passing an order under section 23‑A of the Income‑tax Act "
8. The departmental representative desires that the following question be also referred to the High Court;
"Whether on the facts of the case the Tribunal was right in allowing the deduction of Rs. 55,459 the excess provision for bonus for the year under reference "
We have stated hereinbefore in paragraph 3 that the Tribunal has taken a consistent stand. It has allowed the assessee a sum of Rs. 1 lakh as provision for bonus as against Rs. 55,459 actually allowed in the award by the Labour Tribunal on a latter date.
Excess provision of the earlier year however was treated as the income of the year. In other words, the amount allowed in the year of account is in reality Rs. 89,567 (1,00,000‑20,433) only.
9. The assessee objects to our allowing the Department to raise this question by the supplementary written reply of the respondent. As the Department had succeeded in appeal before the Tribunal it was not affected by the decision on this point in the appeal. Now that a reference has been asked for by the assessee, it is only fair that this question be also considered. It may be necessary to adjudicate upon it if the view taken by the Tribunal was not upheld by the High Court. , We think that it will be open to the Department to urge this view‑point before the High Court, and no separate question need be framed.
10. The parties agree to the statement of the case. No suggestions are offered.
N. A. Palkhivala for Assessee.
G. N. Joshi for Commissioner.
The assessee is a private limited company. For the year of account 1949‑50 according to the balance‑sheet a net profit of Rs. 3,367, resulted in the business of the assessee. The assessee distributed Rs. 12,800 as dividend to the shareholders. In the assessment proceedings the Income‑tax Officer assessed the assessable income of the assessee at Rs. 1,37,693. The Income‑tax Officer disallowed to the assessee Rs. 55,459, included for excess provision for bonus for the year under reference, Rs. 33,000, for under‑valuation of stock and Rs. 20,433, for excess provision for bonus for 1947‑48 and 1948‑49. He also disallowed Rs. 45,020, on charity account and R9. 1,053, on Diwali account and made a slight adjustment in respect of the claim for depreciation. Finding that the assessee had not distributed as dividend sixty per cent. of the assessable income less the amount income‑tax and super‑tax payable by the assessee, the Income‑tax Officer passed an order under section 23‑A of the Income‑tax Act. Against that order an appeal was preferred to the Appellate Assistant Commissioner, and the matter was ultimately brought before the Tribunal. The Tribunal observed that in considering whether an order under section 23‑A may be passed against the assessee the Income‑tax Officer ought to have regard to the commercial profits and not the assessable profits. The Tribunal assessed the com mercial profits of the assessee, as at the date on which the amount of dividend was resolved to be distributed, at Rs. 56,800. Computing on that amount a tax liability of Rs. 19,325, the Tribunal held that Rs. 37,475, were the net commercial profits of the assessee for the year under reference and sixty per cent. of that amount being Rs. 22,485, and as the assessee had distributed as dividend only Rs. 12,8000, an order under section 23‑A of the Income‑tax Act was properly passed by the Income‑tax authorities.
In this reference, Mr. Palkhivala for the assessee has contend ed firstly, that the Tribunal was in error in estimating the tax while assessing the net commercial profits at Rs. 19,325 and, secondly, that the Tribunal was in error in adding the amount of Rs. 20,433, standing to the credit of the bonus provision account to the net profit of Rs. 3,367, in ascertaining the profit available for declaration of dividend.
Section 23‑A of the Income‑tax Act, as it stood before its amendment by the Finance Act, 1955, in so far as it is material, provided by the first subsection;
" Where the Income‑tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company up to the end of the sixth month after its accounts for that previous year are laid before the company in general meeting are less than sixty per cent. of the assessable income of the company of that previous year, as reduced by the amount of income‑tax and super‑tax payable by the company in respect thereof he shall, unless be is satisfied that having regard to losses incurred by the company in earlier years or to the smallness of the profits made, the payment of a dividend or a larger dividend than that declared would be unreasonable, make . . . an order in writing that the undistributed portion of the assessable income of the company of that 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 amongst the shareholders as at the date of the general meeting aforesaid, . . ."
The object of the section is to prevent the avoidance of liability to pay super‑tax by the shareholders of companies in which the public are not substantially interested. Income‑tax paid by the company on its profits is by section 49‑B of the Act deemed to be paid on behalf of the shareholders, but the share holders have to pay super‑tax on dividends received by them even if the company has paid super‑tax out of its profits. The rates of super‑tax applicable to companies are substantially lower than the rates applicable to other assessees. Lest by the expedient of not distributing the dividends and converting the accumulated profits with the company into capital and distributing the same as bonus shares, the higher rate of super‑tax may be avoided, the Legislature enacted this section. The provisions of this section are in terms (subject to an exception to be presently noticed) mandatory, if the condition that the profits and gains distributed as dividends are less than sixty per cent. of the assessable income reduced by the income‑tax and super‑tax payable by the company is fulfilled. The Income‑tax Officer has, however, a discretion not to make an order if he is satisfied that, having regard to the losses incurred by the company in the earlier years, or to the smallness of the profits made, the payment of a larger dividend would be unreasonable.
It is undisputed that the Income‑tax Officer assessed the total profits of the assessee at Rs. 1,37,693, and the tax payable in respect thereof was Rs. 49,689. Sixty per cent. of the balance considerably exceeded the total dividend declared by the assessee, and Mr. Palkhivala for the assessee has not contended that the case is one in which the primary condition about the inadequate distribution of profits or income as dividends was not satisfied.
But he contends that even if the primary condition is fulfilled, the Income‑tax Officer had to consider whether, having regard to the smallness of the profits made, payment of a larger dividend than the one declared would be unreasonable. Mr. Palkhivala says that having regard to the smallness of the profits made by the assessee it would, in the circumstances of the present case, be unreasonable to declare a larger dividend.
It is now well settled that the expression "profit made" in section 23‑A, subsection (1), names commercial profits and not assessable profits. In Commissioner of Income‑tax v. Smidth & Co. (Bombay) Ltd. ((1959) 35 IT R 183) a Division Bench of this Court (to which my learned brother was a party) held that in considering the smallness of the profits made by a company the profits that the Income‑tax Officer had to consider were not the total income referred to in section 23‑A (1) but the actual profits from a com mercial point of view. The Income‑tax Appellate Tribunal has (as it was bound to) followed that view and has, in paragraph 6 of its judgment, proceeded to assess the commercial profits of the assessee at Rs. 56,800. But that was evidently the gross com mercial profits of the assessee as at the date on which the general meeting for resolving upon the distribution of dividend was held. Out of this amount the Tribunal purported to deduct Rs. 19325, which was the appropriate tax payable in respect of an income of Rs. 56,800. In our view, in making a deduction of Rs. 19,325 only for tax liability the Tribunal was in error. The income‑tax payable by an assessee does not bear any definite relation to his commercial profits. Even if the assessee has made payments which he is not entitled to deduct in ascertaining the assessable income, the commercial profits are to that extent depleted. It would, therefore, in our judgment, be an error to reduce merely the amount of tax computed on the commercial profits to ascertain the profits made. Before the Tribunal it was contended that out of the commercial profits the total amount of tax parable by the assessee should be deducted. The Tribunal was of the view that the assessee must adopt one of two methods, viz., (i) to deduct from the assessable income the amount of tax paid and thereafter to ask the Income‑tax Officer to ascertain whether the profits were so small that an order under section 23‑A (1) need not be passed, or (ii) to confine itself to the circumstances existing as at the date on which the general meeting was held and to take the commercial profits as the basis and to deduct therefrom the appropriate tax payable on the profits so ascertained. But the question is, in our judgment, not of any option vested in the assessee. The Income tax Officer has to exercise his powers subject to the limitations prescribed by section 23‑A. The first condition of which he must be satisfied is that the profits and gains distributed by the assessee as dividend amongst the shareholders is less than sixty per cent. of the assessable income as reduced by the amount of income‑tax and super‑tax payable in respect thereof. Even if this condition is satisfied, if, having regard to the losses sustained in the previous years or to the smallness of the profits made, it would be unreason able to distribute a dividend larger than the one declared, the Income‑tax Officer will not pass the order that the undistributed portion of the assessable income shall be deemed to be distributed as dividends. It was, therefore, for the income‑tax Officer to ascertain, having regard to the commercial profits, the anticipated amount of tax which would have to be deducted to find out the net commercial profits, in the light of all the circumstances then present to its mind, and thereafter to relate the same to the amount of dividend declared. If, having regard to the net commercial profits so ascertained, it appeared to the Income‑tax Officer that it would not be unreasonable to distribute sixty per cent. of such income as dividend amongst the shareholders, an order under section 23‑A of the Income‑tax Act may properly, be passed. In the present case. The Tribunal having proceeded to deduct only an amount of Rs. 19,325, which was the amount of tax payable on an income of Rs. 56,800, in our view, an error has been com mitted in confirming the order passed by the Income‑tax Officer under section 23‑A of the Act.
Mr. Palkhivala contends that even the commercial profits ascertained by the Tribunal were erroneously ascertained. Accord ing to him, the commercial profits of the assessee amounted to Rs. 36,367 and no more, and the amount of Rs. 20,433 under the head "bonus excess provision ‑credited to the profit and loss account" was wrongly included in the commercial profits. This argument of Mr. Palkhivala we are unable to accept. In order to appreciate this argument, it may be necessary to state a few facts. The assessee had year after year been setting apart certain amounts towards liability likely to arise for payment of bonus to the labourers employed in its factory. Normally the assessee used to set apart every year an amount approximately equivalent to three months' salary payable to the employees. It appears, however, that in 1947‑48, the provision made on this account exceeded the amount actually paid as bonus by Rs. 218‑5‑6 ; in the year 1948‑49 it exceeded by Rs. 3,972‑12‑6 and in the year 1949‑50, the provision made on this account exceeded the actual liability by Rs. 16,241‑12‑3. At the commencement of the year 1950‑51 the assessee had an accumulated amount of Rs. 20,432‑14‑3 in the bonus provision account and it set apart an amount of Rs. 1,00,000 towards the contingent liability for payment of bonus to its employees in that year. The employees had claimed an amount equivalent to four months' salary as bonus payable to them. The dispute was taken to the Industrial Court and ultimately by order, dated 28th February, 1951, an award was made whereby the liability of the assessee to pay bonus to its employees for that year was restricted approximately to half the amount set apart. But in assessing its commercial profits the assessee sought to deduct the entire amount of Rs. 1,00,000. The Income‑tax Appellate Tribunal held, having regard to the claim made by the employees, that the assessee did not act unreasonably in setting apart Rs. 1,00,000 towards the contingent liability for bonus, but it was of the view that the assessee should have taken into consideration the accumulated amount of Rs. 20,432 odd before setting aside a further amount to meet that contingent liability. The Tribunal, therefore, added the amount of Rs. 20,432‑14‑3 to the profits for the year under account and computed the com mercial profits on that footing. In our view, the Tribunal was right in so doing. If there was an undisbursed residue of Rs. 20,432‑14‑3 in the bonus provision account, and the assessee was faced with a claim for bonus which was not defined but the extent whereof was estimated at Rs. 1,00,000 the assessee was bound to take into account the amount lying accumulated and to make a provision during the year under account only for the balance. Mr. Palkhivala contends that the amount of Rs. 20,432‑14‑3 did not represent the accumulated amounts of excess in the bonus provision account out of the sums set apart during the previous years, but that it represented amounts which were due and payable as bonus to the employees but which were for certain reasons not received by them. No such argument, however, appears to have been raised before the Tribunal, and we do not think we will be justified in allowing Mr. Palkhivala to raise this new plea for the first time before us.
Mr. Joshi for the Department contends in the first instance that the expression "profit made" occurring in section 23‑A (1) of the Income‑tax Act means the gross profits realised by the assessee without deducting the amount of tax payable by it. But evidently section 23‑A is enacted with a view to prevent accumula tion of large amounts of profits without distribution of adequate dividends ; and dividends can only be distributed after deducting the amount of tax payable from the assessable income of the assessee. It is only after the tax payable by the assessee is deducted from the assessable income that there will be a net profit remaining with the assessee distributable as dividend amongst the shareholders. If the view contended for by Mr. Joshi were to be accepted, the assessee may have to pay dividend out of its reserve. We are, therefore, unable to accept the argument that the expres sion "profit made" occurring in section 23‑A (1) is the gross com mercial profit without deducting the amount of tax payable.
Mr. Joshi has then contended that the amount of tax deductible out of the commercial profits must be appropriate to its quantum. That argument also we are unable to accept. As we have already observed, the commercial profits bear no real relation to the assessable profits, and the tax is payable on the assessable profits and not on the commercial profits.
Mr. Joshi has finally contended that in any event the assessee may be entitled to deduct from the gross commercial profits only such amount as tax as he could, having regard to its transactions, have anticipated as likely to be imposed by the Income‑tax authorities and not the total amount of tax which may ultimately be assessed. That argument, in our judgment, has substance. If, with a view to provide for contingent liabilities, the assessee has appropriated a certain amount, evidently the tax which he must have anticipated as likely to be imposed on him will have to be computed after excluding from its gross profits the amount so set apart. The assessee cannot contend that in assessing the net commercial profits the whole of the amount so set apart for meeting contingent liabilities should be deducted whereas in assess ing the tax which he must have reasonably expected as payable by him the total‑amount of tax assessed by the income‑tax authorities should be deducted.
The Tribunal has held that the net commercial profits made by the assessee during the year under account amounted to Rs. 37,475. That, for reasons set out earlier, is erroneous. We are unable, on the materials before us, to ascertain the amount of tax which may have been reasonably anticipated by the assessee, as likely to be assessed having regard to its transactions at the date on which the dividend was declared at the general meeting, viz., 25th July, 1950. In that view of the case, we are unable to answer the question which has been framed by the Tribunal. We, therefore, remand the case to the Tribunal with a direction that the Tribunal do submit a supplementary statement of the case setting out the appropriate amount of income‑tax which would be deductible out of the amount of Rs. 56:800 and which the assessee may have reasonably anticipated as likely to be assessed after taking into consideration the profits made by it and the contingent liability for payment of bonus to the employees of its factory. The supplementary statement to be submitted before 31st December, 1959.
M. N. Case remanded
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