COMMISSIONER OF INCOME-TAX, BOMBAY CITY I, BOMBAY versus JUBILEE MILLS LTD. BOMBAY

A COMMISSIONER OF INCOME-TAX, BOMBAY CITY I,

BOMBAY v. JUBILEE MILLS LTD. BOMBAY December 5, 1967 [J. C. SHAH, V. RAMASWAMI AND V. BHARGAVA, JJ.J

Income Tax Act, 1922, s. 23-A-Company reconstructing capital to write off· accumulated losses and reducing capital-Whether losses prior to reconstruction relevant for determining reasonableness of company not declaring dividend in subsequent year as prescribed by s. 23-A-S. 66(5) -Procedure to be followed by Tribunal after High Court deciding ques tion against the view taken by Tribunal.

The respondent company had suffered large losses in the years prior to 1930 aIJd in that year it reconstructed its capital by adjusting a debit balance of Rs. 12,75,000 in the profit and loss account against the paid up capital and reducing the face value of its shares. For the accounting year relative to the assessment year 1948-49, the respondent Company declared a dividend amounting only to Rs. 24,750 although in terms of s. 23-A of the Income-tax Act, 1922, it was prima facie liable to declare a much largeT dividend. The Income-tax Officer therefore held that the company should be deemed to have declared a dividend of Rs. 3,98,798. The respondent's appeals against this order to the Appellate Assistant Commissioner and the Appellate Tribunal were dismissed. The Tribunal rejected the respondent's contention that in view of th'e past losses suffered by the cempany, it was not reasonable to expect it to dectaie a larger It held that after the reconstruction of its capital the company dividend. emerged in a new cloak of reduced capital and for the purposes of deter• mining the applicability of s. 23-A the reconstructed capital alone had tQ be taken into account and not the original capital, a great portion of which had been wiped out by debiting losses. The High Court, upon a reference, held that thi: loss of Rs. 12,75,000 incurred by the company prior to its reconstruction in 1930 could be taken into consideration for the purposes of the applicability of s. 23-A. On appeal to this Court, HELD : (i) The view taken by the Appellate Tribunal was erroneous in law and the High Court had rightly answered the question referred to it in favour of the respondP.nt-company.

Th<Te is nothing in the language or context of s. 23-A(l) of the Act to suggest that the expre~:;ion "Josses incurred in the earlier years" should be construed so as to exclude losses incurred prior to the reconstruction , "and to include only unadjusted or carried forward losses still outstanding in the books of the company, The section requires the Income-tax Officer to take into consideration "the losses incurred by the company in the ear lier years'' or the "sma1Jness of profits made" It is well-established that the profits which are to be considered under s .. 23-A (I) are the commercial or the accounting profits and not the assessable income or the assessable profits of the company, because it is the commercial or the actual account- ing profits which arc to form the source from which the diVidend is to be distributed and not the assessable income or assessable profits which may have no relation to the commercia1 or accounting profits and which arc not the actual source out of which the dividend could be paid. [544 G-H: 545 A-CJ

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C.l.T. West Bengal v. Gangadliar Ranerju, ~1 J.T.R. 176, referred to. A

If a c.omp~ny v.·~ich has got over its losses for ~ome year.. by adjusting them against lls capnal anJ rc(fucing its capi1al males a profit in the 11ub scq~1t::nt y~ar it may the0rctic:11ly be in a P<'Sition to di;\tribute the whole of .11s prollls 'or that ycJ.r but it cannot he said to have ac:ed unreasonably !f it t..:hosc not to do sn and n:taincd a portion of the profits for the pUr- posc of builJin~ up a capitJI reserve wh!ch in cour~e or time \\'ould enable :he company to regain ib origin;il strength of capital. It may he- th.at even ~1ftcr 1:ak.ing iat;.) co;isideration IOS'>~ prior to a reconstructi:l:J it i~ µossible to come to the cono:Ju..,ion 1hat t}ie companv y,.·as not justified in not dcclar· iog a larger di\':dcnd than that actually de..:lared. Hut in the preiirot case the Tribun;,il !:at! rni'ldl;ccted itsc!f in law in holdint! that lo\!c~ incurred prior h .. the recon~tru:;tion ;i.rc irrelevant for the purPosc of applic.11tion of s. 23-A in suhsequent yea". [545 E-G; 546 A-Bl

(ii) The High Coun having rightly answered the question referred to it in favour of the as,..:ssee meant that the ·rribuaal must now. io confor- mity with the judgment of th-o High Coun. act under " 66(5) of the Act, 1bat i~ to say, dispose of the case 1fter l'(:-hcaring the respondent company an<l the Commis.s.ione; 10 thr.: light of the evidence and according to law. [547 B-DJ

Income-tax Appellate Tribunal. Bomba;t and Ors, v. S.C. Cambatta & fathuri Aswathiah v. The C.1.T. M7sore,

Co. Ltd. 29 l.T.R. 118 C.A. No. 631.' 1966 dated 18-4-67, referred to.

and

CIVIL APPELLATE JURISDICTION: Civil Appeal No. 525 of

1967.

Appeal from the judgment and order dated May 3/ 4, 1963 of the Bombay High Court in Income-tax Reference No. '40 of 1957.

B. Sen and R. N. Saclrthey, for the appellant.

S. F'. Mehta, S. E. Dastoor ar:d

/. N. Shroff, for the respon

dent.

The Judgment of the Court was delivered by

Ramaswami, J. This appeal is brought, by certificate, from the judgment pf tl'c Llomhay High Court dated May 3/4, 1963 io 1 ncome T:L~ Reference No. 40 of 1957.

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The respondent-company is a limited liability company with a paid up capital of Rs. 15.25,000/- as on June 30, 1947. Prior to 1930 :he respondent-company had <uffered large losses and in G 1930 a debit balance of Rs. 12·.75,000/- in the profit and loss ;iecoum of the respondent-company was adjus1ed by reducing the paid up capital. The face value of the Ordinary shares was reduced from Rs. 100/- to Rs. 10/- each and of Preference shares from Rs. 100/- •o Rs. 25/- each after obtaining the sanct'on vf the Bombay High Courl. For the assessment year 1948-49, for which the relevant previous year was the year ended June 30. 1947. the respondent-company was assessed to a total income of Rs. 7.47,6'9/-. On tax was calculated at

amount

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C.I.T. v. JUBILEE MILLS (Ramaswaml, J.)

541

the

'Act') was,

Rs. 3,27,091/- and the balance available for distribution by way of dividends for the purpose of s. 23A of the Income-tax Act, 1922 (hereinafter referred to as therefore, Rs. 4,20,548/-. Section 23A of the Act requires a company in which the public are not substantially interested to declare in the absence of certain special c:rcumstances a dividend which would not be less than 60% of the said balance. The respondent company the1efore was prima facie liable to declare a dividend of at least Rs. 2,52,358/- in order to escape the penal consequences of non-compliance with the provisions of the said section. The actual dividend which was declared by the respondent-company was only Rs. 24,750/-. The Income-tax Officer with the previous approval of the Inspecting Assistant Commissioner, therefore, applied the provisions of s. 23A of the Act to the respondent company and held that the company should be deemed to have declared a dividend of Rs. 3,95,798/-. The respondent-company appealed to the Appellate Assistant Commissioner of Income-tax against the order of the Income-tax Officer but the appeal was dismissed. The respondent-company thereafter filed a second appeal to the Income-tax Appellate Tribunal. By its order dated September 7, 1955 the Appellate Tribunal confirmed the order It was made under s. 23A of the Act' and dismissed the appeal. contended before the Appellate Tribunal on behalf of the respon dent-company that in view of the past losses suffered by it the non declaration of a dividend larger than that actually declared was not unreasonable. It was argued that in view of the past losses of Rs. 12,75,000/- it was not reasonable to expect the respondent the wmpany to declare a larger dividend. The argument of respondent-company was rejected by the Appellate Tribunal. It stated as follows in the course of its order:

"It is true that company incurred large losses in past years. But it reconstructed its capital in 1930. In that year, the debit balance in the profit and loss account had been set off against the paid-up capital thereby re ducing the paid-up capital of the company. After the reconstruction, the company emerged in a new cloak _of reduced capital. For the purpose of determining the applicability of provision of Section 23A, in our view, the reconstructed capital alone has to be into account and not the original cap;tal. a great portion of which had been wiped out by debiting losses. Those prior losses had already been wiped out by writing off against the paid up capital. They cannot now be taken for consideration." At the instance of the respondent-company

taken

thy Appellate Tribunal referred the following questions of law for the opinion of the Bombay High Court :

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. .. I. Whether on the facts and in the circumstances ot the ca1e, the Income-tall Officer was competent to pas, an 01der u/s. 23(1) of the Act after having allow ed a rebate of one aana per rupee in the assessment under t.he proviso (a) to paragraph (B) of Part I of the Second Schedule of the Finance Act, 1948 ?

2. If the answer to question No. I is in the affirma tive whether on the facts and in the circumstances of the c~se, the asscssel'. company is a company in which the pubhc are substantially interested for the purposes of sec. 23A of the Act '' and

3. Whether the loss of Rs. 12.75.000/- incurred by the company prior to its reconstruction in 1930, could be taken into consideration for purposes of the appli cability of sec. 23A (1) of the Act ?"

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By its judgment dated March 13, 195.8 the High Court answered the first question in the affirmative, holding that the Income-tax Officer was competent tu pass an order under s. 23A(l) and he was not precluded from doing so by reason of his having granted rebate to the respondent-company. On the second qt1estion also the High Court gave its answer in the affirmative, holding that the respondent.company was a company in which the public was In >Ubstantially interested for the purpose of s. 23A of the Act. view of the answer to the second question the provisions of s. 23A of the Act would not be applicable to the respondent-company and the third question hecame academic, and the High Court declined to answer it. The CommL<;.sioner of Income-Tax took the matter in appeal to this Court which reversed the answer which the High Court had given to question No. 2 and held that the respondent company was a company in which the public were not substan tially interested for the purpose of s. 23A of the Act. In view of the decision of this Court on the second question it became neces sary for the High Court to consider the third question and this Court therefore remanded the reference fo the High Court for con sideration of the third question. After the remand the High Court heard the reference again and by its judgment dated May 3 / 4, 1963 answered the third question in the affirmative and in favour It was held by the High Court that of the respondent-company. the losses prior to reconstruction of the respondent-«impany in 1930 which were set off against the paid-up capital could be taken into consideration for the purpose of application of s. 23A of the Act.

Section 23A of the Act before its amendment in 1955, in so

far as it is material, states as follows:

"23A. Power to assess individual members of certain

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C.l.T. v. JUBILEE MILLS (Ramaswaml, !.)

543

( 1) where the income-tax officer is satisfied that in respect of any previous year the profits and gains dis tributed as dividends by any company upto 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 com pany 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 Inspecling Assistant Commissioner an order in writing that the undistributed portion of the assessable income of the company of that previous year as com the puted for income-tax purposes and reduced by the amount of income-tax and super-tax payable by company in respect thereof shall be deemed to have been distributed as dividend amongst the shareholders as at the date of the general meeting aforesaid and thereupon the proportionate share thereof of each share holder shall be included in the total income of such shareholder for the purpose of assessing bis total income :

Provided further that this sub-section shall not apply to any company in which -the public are substantially interested or to a subsidiary company of such a com pany if the whole of the share capital of such subsidiary company is held by the parent company or by the nominees thereof.

to be a company

Exp/anation.-For the purpose of this sub-section, a company shall be deemed in which the public are substantially interested ·if shares of the company (not being shares entitled to a fixed further rate of dividend, whether with or without a right to participate in profits) carrying not than twenty-five per cent of the voting power have been allot ted unconditionally to. or acquired unconditionally by, and are at the end of the previous year beneficially held by the public (not including a company to which the pro visions of this sub-section apply). and if any such shares have in the course of such previous year been the subject

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of dealings in any stock exchange in the taxable terri tories or arc in fact freely transferable by the holders to other members of the public."

The applicability of s. 23A of the Act is therefore attracted when it is found that the company in which the public are not substantially interested has declared a dividend of less than 60% 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 for any previous year. The section, however, has provided that even if the applicability of the section is attracted, the Incomc tax Officer has to consider whether, having regard to the losses incurred by the company in earlier years or having regard to the smallness of its profits, it would have been unreasonable for the company .to declare. a dividend larger than which it had actually declared .. The object of the section is to collect super-tax from the shar.eholders which would be payable if the company had dis tributed its income by way of dividends and to discourage avoid ance of •;ix by failing to distribute its income.

On behalf of the appellant Mr. B. Sen put forward the· argu ment that as a result of the reconstruction of the capital in 1930 a new chapter had opened in the life of the respondent-company and losses which it had suffered prior to the reconstruction of its capital were irrelevant and should not be considered for the pur pose of s. 23A of the Act so.far as subsequent years are concerned. It was said that for determining the application of s. 23A of tho the original Act it was the reconstructed capital alone and not capital that had to be taken into account. It was PO;!lted out that though the reduction of 'he capital h3d been necessitated by lesses ouffered, the reconstruction of the capital had resulted in wiping out the losses and star·ini! the company afresh with reduced capital as its paid-up share c.apital. The argument was stressed that where the company adjusts losses against the paid-up capital and reconstructs its capital, the financial position of the company and its dividend distributing capacity in subsequen! years have to be judged only by the result of its tradin~ after reconstruct;on and not with reference 10 earlier losses which have disappeared by ad justment. In our opinion. there is no warrant for the acgument put forward on behalf of the appellant. There is nothing in the langua!!e or con•ext of s. 23A (I) of the Act to suggest that the expression "losses incurred in the earlier years" should be construed so as to ex clude losse~ incurred.prior to the reconstruction and to include only unadjusted or carried forward losses still outstanding in the books of the company. In our opinion, the losses which have been ad justed in the books of the company at the time of reconstruction do not cease to be "losses incurred hy the company in the earlier years" within the meaning of s. 23A ( 1). The section requires

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line of

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the Income-tax Officer to take into consideration "the losses in, curred by the company in the earlier years" or "the smallness of It is well-established that the profits which are to profits made." be considered under s. 23A(l) are the commercial or the account ing profits and not the assessable income or the asse.ssable profits of the company, because it is the commercial or the actual accounting profits . which are to form the source from which the dividend is to be distributed and not the assessable income or assessable profits which may have no relation to the commercial or accounting profits and which are not the actual source out of which the dividend could be paid.-See C.l.T., West Bengal v. the Gangadhar Banerjee('). On a similar consideration of losses in the earlier years should be made in the setting and conte/(t of the inquiry whether the company could be regarded as acting reasonably in declaring a smaller dividend. It is true that as a result of the losses having been adjusted against the paid-up capital they no longer remain as unadjusted losses or carried for)Vard losses but it does not mean that they cease to have any i.p1pact on the financial position of the company in sub sequent yetti;s. Even if the company resorts to the method of wiping out the losses by adjusting them against its capital, the in procedure results in crippling its finances and the company future.)'ears may reasonably take steps for improving its crippled financial position. If therefore a company which has got over its losses for some years by adjusting them against its capital and reducing its capital makes a profit in the subsequent year it may theoretically be in a position to distribult> the whole of its profits for that year but it cannot be said to have acted unreasonably if it chose not to do so and retained a portion of the profits for the purpose of building up a capital reserve which in course of time u1ould enable the company to regain its original strength of capital which had been crippled by the adjustment of losses at the time of reconstruction. We are therefore unable to accept the argu ment put forward on behalf of the ·appellant on this aspect of the case. In our opinion, the Appellate Tribunal mis-directed itself in law in holding .that the losses incurrecj. prior to the reconstruc tion of the respondent-company are irrelevant far the purpose of application c•f s. 23A of the Act in subsequent years. As we have already said, the losses incurred prior to the reconstruction hav ing been adjusted are no longer shown in the books of the com pany. It does not, however, mean that the losses cease to have their effect on the financial posftion of the company in subsequent It cannot therefore be said .that the losses prior to recon years. struction do not fall within the ambit of the expre>sion "losses in curred by the company in earlier years" for the purpose of the application of s. 23A of the Act. Such losses are relevant to be considered even though they may not be surviving in the books of (1) 57 LT. R. 176. L2Sup Cl/68-4

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the C-Ompany as un_adjusted or carried forward losses. that even after talong s_uch losses into e-0nsideration it is possible to come to the conclusion that the company was not justified in not declarin~ a larger dividend than that. actually declared. But what the Tnbunal has done in this case is that it has refused to take such losses into account at all because it has taken the view that by their adjustment against the capital the losses do not sur- B \"!Ve for coqsideration for the purpose of the application of s. 23A of the Act. The view taken by the Appel!a•e Tribunal is erro neous in law and we arc of opinion that the High Coun has right- ly answered the third question in the affirmative and in favour of the respondent-company.

But it is necessary to give certain effective directions, so that a mere order of dismissal of this appeal may not result in injustice. Section 66(5) of -the Act requires the Tribunal on receiving · a copy of the judgment of the High Court to pass such orders as are necessary to dispose of the case conformably to such judg ment. The section clearly imposes an obligation upon the Tribunal to dispose of the appeal in the light of and conformably with the judgment of the High Court. If the High Court agrees ~ith the .,iew of the Tribunal, the appeal may be di5posed of by a formal order. But if the High Court disagrees with the Tribunal on a ques!ion of law, the Appellate Tr'bunal must modify its order in the light of the order of the High Court. If for example the High Court has held that the judgment of the Tribunal is vitiated, because it is based on no evidence or because the judgment pro ceeds upon a mis-cons•ruction of the Appellate Tribunal would be under a duty to dispose of the case confonn ably with the opinion of the High Court and on the merits of the dispute; and rehear the appeal after giving notice to the parties In Income-tax Appel and redetermine ir in accordance with law. late 1'riburw/. Bc>mbay and Ors. v. S. C. Camba/la and Co. Ud., (') the Bombay High Court explained the procedure to be followed JS under :

the statute,

"when a reference is made lo the H;l!h Court either under s. 66 (I ) or section 66 (2) the decision of the Appellate Tribunal cannot be looked upon as final; in other wQrds. the appeal i5 not finally dispooed of. It is only when the High Coun decide<: the case, exercises its advi~;ory jurisdiction, and gives directions to the Tri bunal on questions of law. and lhe Tribuna1 reconsiders the matter and decides it, tha• the aope~l is finally disposed of. ......... it is clear that what the Appel- late Tribunal is doing after the High Court has heard the case is to exercise its appellate powers under section

(I) 29 I.T.R. t IS

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C.I.T. v. JUBILEE MILLS (Ramaswaml, /.)

547

33 ........... The shape that the appeal would ulti- mately take and the decision that the Appellate Tri bunal would ultimately give would entirely depend upon the view taken by the High Court."

This passage was quoted with approval by this Court in Esthuri Aswathiah v. The C.1.T., Mysore('). In the present case, the High Court has held, and we agree with the High Court, that fte judgment of the Appellate Tribunal is vitiated in law because it has proceeded on an erroneous interpretation of the statute. The High Court accorwngly answered the third question in the affirma tive and in favour of the respondent-company. We must make it clear that the answer of the High Court to this question mean• that the Appellate Tribunal must now, in conformity with the judgment of the High Court, act under s. 66 ( 5) of the Act, that is to say, dispose of the case after company and the Commissioner in the light of the evidence and according to law.

rehearing

the

respondent- ·

Subject to this wrection. the appeal is dismissed with costs.

R.K.P.S.

Appeal dismissed.

(I) Civil Appeal No. 631 of '!~66. decided on April 18, 1967.