Decided on August 20,1962



Y.S.TAMBE, J. - (1.)THIS is a reference under Sub -S. (1) of S. 66 of the Indian IT Act (hereinafter referred to as the Act) at the instance of the CIT. The question referred to us in the following terms : "Whether, on the facts and in the circumstances of the case, the sum of Rs. 50,000 being the amount paid to Mr. Jariwala as per the compromise was deductible in considering the application of s. 23A ? "
(2.)THE following facts give rise to this question : The assessee is a company in which the public are not substantially interested within the meaning of S. 23A of the Act. For the asst. year 1952 -53, it returned an income of Rs. 1,56,894. The ITO, however, after disallowing certain expenditure said to have been incurred by the company, computed its income at Rs. 2,33,466. The tax payable thereon was worked out at Rs. 1,01,412. The balance available for profits as per the assessment order of dt. 31st July, 1954, was Rs. 1,32,054. The ITO, finding that the dividends declared by the assessee company was less than 60 per cent of the assessable income of the company as reduced by the amount of income -tax and super -tax payable in respect thereof, made an order under s. 23A that the undistributed portion of the income of the assessee as reduced by the amount of tax payable thereon be deemed to be the dividends distributed among the shareholders. It appears that before the ITO the assessee had contended that it had to pay Rs. 21,320 as secret commission for the purpose of its business and this should be taken into account in determining the smallness of the profits. It was also the contention of the assessee that it had paid a sum of Rs. 50,000 to Dr. Jariwala in the year of account in pursuance of a compromise arrived at between Dr. Jariwala on the one hand and the company on the other in a then pending litigation. The assessee company claimed that this item should also be taken into account in determining the issue of smallness of profits. According to the assessee if these amounts are taken into account in determining the available profits for distribution, it could not be said that the assessee company could have reasonably distributed dividends larger than those distributed by the company.
At this stage it would be convenient to mention the circumstances which gave rise to the litigation started by Dr. Jariwala. It appears that, prior to the year 1947, there was a partnership firm known as " Chunilal and Jariwala " consisting of two partners, the present assessee company and Dr. Jariwala. This partnership firm, i.e., "Chunilal Jariwala", were the managing agents of Estrella Batteries Ltd. This firm resigned its managing agency by its letter dt. 22nd April, 1947, and the resignation was accepted by Estrella Batteries Limited. Thereafter, Dr. Jariwala filed a suit in this Court (Suit No. 3462 of 1947) alleging that the signature to the letter of resignation of the managing agency was not properly obtained and that a sum of Rs. 8 lakhs must be paid as compensation for loss of agency. The suit was filed both against Estrella Batteries Ltd. and the assessee company, the assessee company being the second defendant therein. After a protracted litigation the suit was ultimately compromised on terms as mentioned in a letter dt. 5th April, 1951, the assessee company agreeing to pay a sum of Rs. 1,25,000 to Dr. Jariwala and Dr. Jariwala agreeing not to prosecute the suit further. Out of the said amount of Rs. 1,25,000, Rs. 50,000 have been paid by the assessee company to Dr. Jariwala in the year of account. As already stated, the assessee had claimed before the ITO that the aforesaid sums of Rs. 21,320 and Rs. 50,000 should be excluded in determining the issue of smallness of profits and profits available for distribution amongst the members. This contention was, however, not accepted by the ITO and he made an order under S. 23A. The assessee took an appeal before the AAC. The AAC accepted the contention of the assessee in respect of the amount of Rs. 21,320, but did not accept the contention of the assessee in respect of the said amount of Rs. 50,000 paid to Dr. Jariwala in the year of account. The reasons given by the AAC have not been stated in the statement of case, but the order has been read to us and it appears that he disallowed the amount on the ground that the expenditure was of a capital nature. He held that even after allowing the amount of Rs. 21,320, the distributed profits fell short of 60 per cent and, in this view of the matter, he affirmed the order of the ITO. The assessee took a further appeal to the Tribunal and the Tribunal has accepted the contention of the assessee and allowed the appeal.

(3.)TO appreciate the argument of Mr. Joshi, learned counsel for the Revenue, it would be convenient to reproduce paragraphs 6, 7 and 8 of the order of the Tribunal containing its reasons for allowing the appeal :
"6. After carefully considering the matter, we are of the opinion that the assessee must succeed. Sec. 23A is a highly technical anti -avoidance device. Its main purpose is to stop the avoidance of super -tax by the simple means of not distributing the dividends and carrying forward the profits, either as reserves or as unappropriated profits which is quite easy when the company is controlled by a few persons having large incomes. To plug this loophole it was enacted in the year 1939 that the ITO could pass an order under S. 23A whereby the profits available for distribution after paying taxes and dividends could be deemed to be distributed as dividends. The right of the ITO is not unfettered; he has to consider the smallness of profits and the previous losses; not is it to be done by a rule of thumb because the Courts have held that the commercial profits should be considered as available for distribution whatever the total income assessed may be.

7. It is necessary to discuss this last aspect in a little more detail because our present case turns on this. The main reason why commercial profits are to be considered for the purposes of S. 23A is that otherwise the ITO may order that a dividend is deemed to be distributed when there is no profit at all to be distributed. A payment may be made - an actual and genuine payment to an outsider - so that no profit is left for distribution; this, however, may be disallowed in an income - tax assessment for good and valid reasons and though there is no avoidance of super -tax - the raison d'etre for S. 23A - still the ITO would hold that a dividend is deemed to be distributed. This is exactly what has happened in the present case. Rs. 50,000 has been paid. If the company had funds which could be distributed and still not distributed it, the position would have been entirely different, but now the company has parted with this money and nothing is left in the coffers to distribute. We have, therefore, no hesitation in holding that S. 23A was not properly applied in this case. 8. During the arguments it was also suggested that the company should not have charged it against the profits of the company, but debited it to some capital account because the payment is of a capital nature. The payment was unmistakably made to get rid of a disturbing element and we doubt whether any auditor could allow it to be capitalised. No asset of enduring nature has come in and we are of the opinion that the payment has been properly charged to revenue even though it is not deductible for income -tax assessment and only after the deduction of Rs. 50,000, one could arrive at the commercial profits. We, therefore, do not accept this contention of the Departmental representative either."

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