BANERJEE, J. - (1.) THIS reference, under s. 66(1) of the Indian IT Act, has been made in circumstances hereinafter stated in brief.
(2.) THE assessee, being a private limited company, it is common ground that in the assessee- company the public are not substantially interested and, as such, the provisions of s. 23A of the Indian IT Act apply to the assessee-company. THE assessment year, which is relevant for the purposes of this reference, is the year 1954-55 corresponding to the financial year ending with 31st March, 1954. THE assessment for the year 1954-55 was computed on a total income of Rs. 73,451, after having set off the losses brought forward from the preceding year. THE tax payable on the total income, as assessed, amounted to Rs. 31,905. On the aforesaid calculation, the distributable surplus came up to Rs. 41,546. THE dividend declared by the assessee-company, at its annual general meeting held on 24th Dec., 1954, was, however, Rs. 12,000 only, which was below 60 per cent of the assessable income. In these circumstances, the ITO proposed to take steps against the assessee-company and gave an opportunity to the assessee- company to show cause why an order under s. 23A(1) should not be made against it. After having considered the assessee's contentions and after having taken prior approval of the IAC, he passed an order under s. 23A(1), deeming the entire surplus of Rs. 41,546 as dividend declared by the assessee-company to the shareholders at the annual general meeting held on 24th Dec., 1954. The assessee appealed before the AAC and contended that the profit as per profit and loss account was only Rs. 52,767 ; deducting therefrom the taxes assessed for the year, the distributable surplus amounted to only Rs. 20,262 ; considering the smallness of the surplus, the dividend of Rs. 12,000, as declared by the assessee-company, was not unreasonable. The AAC, however, negatived the contentions of the assessee and upheld the action taken by the ITO. The assessee preferred a further appeal before the Tribunal. The Tribunal found that the profits for the year ending 31st March, 1954, as per profit and loss account, amounted to Rs. 98,299. The Tribunal further found that there was a carry-forward in the balance-sheet of previous losses amounting to Rs. 45,532. Deducting the sum of Rs. 45,532 from the profits of Rs. 98,299, the commercial profit came up to Rs. 52,767. The Tribunal, therefore, expressed the following view : "If the tax assessed for the year, amounting to Rs. 31,905, is deducted therefrom (meaning thereby the commercial profit), it leaves a balance of Rs. 20,862 which is available for distribution as dividend. The assessee had declared a dividend of Rs. 12,000 which thus falls short of 60 per cent by about Rs. 500. The distribution, however, was more than 55 per cent of the profits available for distribution. Quite apart from the question whether a distribution of a larger dividend would have been unreasonable or not, we find that no notice under the second proviso to s. 23A(1) as it stood at that time had been given to the assessee-company by the ITO giving it an opportunity to declare further dividend to make up the deficiency. Under the second proviso to s. 23A(1), as it stood at the relevant time, no order under that section could be made where a company had distributed not less than 55 per cent of the assessable income of the company as reduced by the amount of the income-tax and super- tax payable by the company in respect thereof, unless the company, on receipt of a notice from the ITO that he proposes to make such an order, fails to make within three months of the receipt of such notice, a further distribution of its profits and gains so that the total distribution made is not less than 60 per cent of the available surplus. In this case, the ITO had clearly not followed the mandatory provisions with regard to the issue of the notice giving the assessee an opportunity to declare a further dividend. The order under s. 23A is clearly vitiated by this defect alone. We would accordingly vacate the order under s. 23A(1) passed by the ITO." Against the aforesaid judgment, the CIT obtained a reference of the following question to this Court for opinion : "Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the order passed by the ITO under s. 23A(1) of the IT Act, 1922, as it stood at the material time, was vitiated by reason of the fact that the ITO had not issued to the assessee a notice under the second proviso to s. 23A(1) before passing the said order." In order to answer the question it is necessary for us to refer to the material provisions of s. 23A as it stood before its amendment by the Finance Act, 1955 : "23A. (1) Where the ITO 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 account 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 the income- tax and super-tax payable by the company in respect thereof, he shall, unless he is satisfied that having regard to losses incurred by the company in earlier years or to the smallness of the profit made, the payment of a dividend or a larger dividend than that declared would be unreasonable, make with the previous approval of the IAC 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, and thereupon the proportionate share thereof of each shareholder shall be included in the total income of such shareholder for the purpose of assessing his total income : . . . Provided further that no order under this sub-section shall be made where the company has distributed not less than fifty-five per cent of the assessable income of the company as reduced by the amount of income-tax and super-tax payable by the company in respect thereof, unless the company, on receipt of a notice from the ITO that he proposes to make such an order, fails to make within three months of the receipt of such notice a further distribution of its profits and gains so that the total distribution made is not less than sixty per cent of the assessable income of the company of the previous year concerned as reduced by the amount of income-tax and super-tax payable by the company in respect thereof . . ." If we analyse s. 23A, we find that the ITO is required to pass an order directing that the undistributed portion of the assessable income of any company (in which the public are not substantially interested) shall be deemed to have been distributed as dividends amongst the share- holders, if he is satisfied that the company has not distributed sixty per cent of its assessable income of the previous year reduced by the amount of income-tax and super-tax payable unless of course the payment of a dividend or a larger dividend than that declared, having regard to losses incurred by the company in the earlier years or the smallness of the profits made in the previous year be unreasonable. The satisfaction, as mentioned above, fulfils the initial condition to the exercise of jurisdiction, under s. 23A, by an ITO.
(3.) NOW, a company normally distributes dividends out of its business profits and not out of its assessable income. The Supreme Court pointed out in the case of CIT vs. Bipin Chandra Maganlal and Co. Ltd. (1961) 41 ITR 290 (SC) : "There is no definable relation between the assessable income and the profits of a business concern in a commercial sense. Computation of income for purposes of assessment of income-tax is based on a variety of artificial rules and takes into account several fictional receipts, deductions and allowances. In considering whether a larger distribution of dividend would be unreasonable, the source from which the dividend is to be distributed and not the assessable income has to be taken into account. The legislature has not provided in s. 23A that in considering whether an order directing that the undistributed profits shall be deemed to be distributed, the smallness of the assessable income shall be taken into account. The test whether it would be unreasonable to distribute a larger dividend has to be adjudged in the light of the profit of the year in question. Even though the assessable income of a company may be large, the commercial profits may be so small that compelling distribution of the difference between the balance of the assessable income reduced by the taxes payable and the amount distributed as dividend would require the company to fall back either upon its reserves or upon its capital which in law it cannot do." Now, in deciding whether action under s. 23A(1) shall be taken, the Tribunal erred in importing considerations of commercial profit in determining the amount of "sixty per cent of the assessable income of the company." The ITO gets jurisdiction to take action under s. 23A only if the distribution of the dividend has been less than sixty per cent of the assessable income. The consideration of the smallness of commercial profits does not come up for consideration at that stage. But even if the ITO assumes jurisdiction, under s. 23A, he may make no order under s. 23A against the assessee if he is satisfied that having regard to the losses incurred by the company in the earlier years or having regard to the smallness of the commercial profit made, the payment of a dividend or a larger dividend than that declared would have been unreasonable. The AAC considered the aspect of the question whether further or larger distribution of dividend would have been unreasonable in the following language : "In appeal it is submitted that the appellant did not have enough cash balance to declare more dividend. A statement has also been submitted showing a capital deficit of Rs. 63,000. According to the statements submitted the distributable surplus was shown at Rs. 20,684, and it is submitted that distribution of Rs. 12,000 as dividend is reasonable in the circumstances of the case. From the balance-sheet I find that the appellant had ready bank balance of about Rs. 72,000, on 31st March, 1954. Even if the appellant did not have bank balance, it is enough if the company declares the dividends and pays it when there were actually cash available. Therefore, there is no substance in the submission regarding paucity of cash balance. From the balance- sheet I find that there are liabilities for about Rs. 7 lakhs. There are correspondingly assets of about Rs. 7 lakhs. The computation of capital deficit of Rs. 63,000 is not correct because this includes profit and loss account balance of Rs. 53,000. Therefore, there is no substance even in this submission of the company." ;