Appeal No 807 of 1963
Appeal from the judgment and order dated September 4 1961 of the Calcutta High Court Income tax Reference No 85 of 1956
CK Daphtary Attorney General R Ganapathy Iyer and R N Sachthey for the appellant
A V Viswanatha Sastri and section C Muzumdar for the respondent
The Judgment of the Court was delivered by Subba Rao J
This appeal by certificate raises the question of the construction of the provisions of section 23A of the Indian Incometax Act 1922 hereinafter called the Act before it was amended by the Finance Act 1955
The relevant and undisputed facts may be briefly stated
Messrs Gungadhar Banerjee  Co Private Ltd the respondent herein is a private limited company
At the General Body Meeting of the Company held on December 6 1948 the Directors declared a dividend at the rate of 5 12 per cent
per share
The said distribution of dividends related to the accounting year 1947 48 which ended on April 13 1948
According to the balance sheet of the Company for that year the net profit for the said year was Rs 12811275
The taxation reserve was Rs 56000
The profit 441 left was Rs 72000
The Directors declared a dividend at the rate of 51 per cent
per share thus making a total distribution of Rs 44000
On that basis the profit that was available for further distribution was Rs 28000
Though under the balance sheet the estimated tax was Rs 66000 the tax assessed for the year was Rs 79400
If the difference between the tax assessed and the estimated tax was also deducted from the profits there would only be a sum of Rs 4000 that would remain as undistributed profits
The Income tax Officer assessed the total income of the assessee for the year 1948 49 at Rs 266766
After deducting the tax payable under the two heads namely IT of Rs 81517130 and CT of Rs 33345120 he held that a sum of Rs 15190270 was available for distribution to the shareholders as dividends
As the amount distributed by the Company was below 60 per cent
of the profits available for distribution the Income tax Officer with the previous approval of the Inspecting Assistant Commissioner of Income tax passed an order under section 23 A of the Act directing that the amount of Rs 107902 ie Rs 151902 minus Rs 44000 Rs 107902 shall be deemed to have been distributed as dividends as on the date of the annual general meeting of the Company
He found that having regard to the profits earned in the earlier years and the capital and taxation reserves payment of larger dividends would not be unreasonable
The assessee preferred an appeal to the Appellate Assistant Commissioner against the order made by the Income tax Officer under section 23A of the Act
By the time the appeal came to be disposed of in an appeal against the order of assessment the assessed income was reduced by a sum of Rs 80926
Notwithstanding the said deduction as the amount of Rs 44000 distributed by the Company was less than 60 per cent
of the balance of Rs 164440 arrived at on the basis of the revised calculation the Appellate Assistant Commissioner held that an action under section 23A of the Act was justified
He further held that the assesee incurred no losses in the previous years that in almost all the past assessments the assessee showed substantial profits that the profits disclosed in the year of account were not small and that therefore the direction to pay a higher dividend was not unreasonable
On a further appeal the Income tax Appellate Tribunal held that the amount of profits should be judged only from the balancesheet and that judged by the figures given thereunder a dividend to the extent of Rs 64000 being 60 per cent
of the assessed profits less income tax could be distributed and that such distribution was not unreasonable
The Tribunal referred the following question under section 661 of the Act for the decision of the High Court of Calcutta Whether on the facts and in the circumstances of the case any larger dividend than that declared by the company could reasonably be distributed within the meaning 442 of Section 23A of the Indian Income tax Act and the application of Section 23A of the Indian Income tax Act was in accordance with law The High Court held that the Tribunal went wrong in taking into consideration the past profits instead of the past losses the taxation reserves without considering the past liabilities for taxation and the profits for the year in question disclosed in the balance sheet ignoring the actual tax assessed for that year
It came to the conclusion that having regard to the smallness of the profits the order of the Income tax Officer was not justified
In the result it answered both parts of the question referred to it in the negative
Hence the appeal
Learned Attorney General appearing for the Revenue con tended that the balance sheet of a company on the basis of which dividends were declared was final and the profits disclosed thereunder would be the correct basis for the Income tax Officer acting under section 23A of the Act and as the balance sheet of the company for the relevant year showed a sum of Rs 105950 as capital reserve brought forward a sum of Rs 573161 as taxation reserve and a sum of Rs 56000 as estimated tax the Income tax Officer rightly held that the financial condition of the Company was sufficiently sound to warrant an order under section 23A of the Act
Alternatively he contended that if the respondent could be permitted to go behind the balance sheet to ascertain the real profit the Department should also be likewise allowed to go behind the balance sheet to show that the commercial profit was larger and the reserves were in excess of the past liabilities and that in that event to remand the case for ascertaining the true state of facts
Mr AV Viswanatha Sastri appearing for the assessee Com pany contended that the burden lies on the Revenue to establish that the dividend declared was not a reasonable one and that in the present case it had not discharged that burden
Idle further argued that for the purpose of testing the smallness of the profit the Income tax Officer had to take into consideration not the assessable Income but the commercial profit of the Company and that in the present case having regard to the commercial profit a declaration of a higher dividend would be unreasonable
He pleaded that should this Court hold that the Income tax Officer could establish that the reserves were more than the liabilities the assessee should also be permitted to prove what were its real commercial profits and that the reserves were far less than the demands
The contentions of learned counsel turn upon the provisions of section 23A of the Act before it was amended by the Finance Act of 1955
The material part of that section reads 1 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 443 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 incometax 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 Inspecting Assistant Commissioner an order in writing that the un distributed 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
 The section is in three parts the first part defines the scope of the jurisdiction of the Income tax Officer to act under section 23A of the Act the second part provides for the exercise of the jurisdiction in the manner prescribed thereunder  and the third part provides for the assessment of the statutory dividends in the hands of the share holders
This section was introduced to prevent exploitation of juristic personality of a private company by the members thereof for the purpose of evading higher taxation
To act under this section the Income tax Officer has to be satisfied that the dividends distributed by the Company during the prescribed period are loss than the statutory percentage ie 60 per cent of the assessable income of the Company of the previous year less the amount of Income tax and super tax payable by the Company in respect thereof
Unless there is a deficiency in the statutory percentage the Income tax Officer has no jurisdiction to take further action thereunder
If that condition is complied with he shall make an order declaring that the undistributed portion of the assessable income less the said taxes shall be deemed to have been distributed as dividends amongst the shareholders
But before doing so a duty is cast on him to satisfy himself that having regard to the losses incurred by the company in earlier years or the smallness of the profit made the payment of a dividend or a larger dividend than that declared would be reasonable
The argument mainly centered on this part of the section
Would the satisfaction of the Income tax Officer depend only on the two circumstances namely losses and smallness of profit Can he take into consideration other relevant circumstances What does the expression profit mean Does it mean only the assessable income or does it mean commercial or 444 accounting profits If the scope of the section is properly appreciated the answer to the said questions would be apparent
The Incometax Officer acting under this section is not assessing any income to tax that will be assessed in the hands of the shareholders
He only does what the directors should have done
He puts himself in the place of the directors
Though the object of the section is to pre vent evasion of tax the provision must be worked not from the standpoint of the tax collector but from that of a businessman
The yardstick is that of a prudent businessman
The reasonableness or the unreasonableness of the amount distributed as dividends is judged by business considerations such as the previous losses the present profits the availability of surplus money and the reasonable requirements of the future and similar others
He must take an overall picture of the financial position of the business
It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income tax Officer
It depends upon the facts of each case
The only guidance is his capacity to put himself in the position of a prudent businessman or the director of a company and his sympathetic and objective approach to the difficult problem that arises in each case
We find it difficult to accept the argument that the Income tax Officer cannot take into consideration any circumstances other than losses and smallness of profits
This argument ignores the expression having regard to that precedes the said words
On the interpretation of the words having regard to in section 23A of the Act the decision of a Division Bench of the Bombay High Court consisting of Chagla C J and Tendolkar J in Sir Kasturchand Ltd vs Commissioner of Income tax Bombay City1 was relied upon by the appellant
Chagla CJ speaking for the Court held in that case that the reasonableness or unreasonableness of the payment of a dividend or a larger dividend has to be judged only with reference to the two facts mentioned in the section viz losses incurred by the company in earlier years and the smallness of the profit To put the contrary construction the learned Chief Justice said would be to import into it words which the Legislature did not think fit to insert in that section and to expand the ambit of the discretion exercised by the Income tax Officer But the learned Chief of Justice did not expressly consider the scope of the expression having regard to found in the section
The Judicial Committee in Commissioner of Income tax vs Williamson Diamond Ltd2 had to consider the scope of section 211 of the Tanganyika Income tax Consolidation Ordinance 27 of 1950 which was pari materia with section 23A of the Act
Adverting to the argument based upon the words having regard to their Lordships observed The form of words used no doubt lends itself to the suggestion that regard should be paid only to the two matters mentioned but it appears to their Lordships that it is 1 2 445 impossible to arrive at a conclusion as to reasonableness by considering the two matters mentioned isolated from other relevant factors
Moreover the statute does not say having regard only to losses previously incurred by the company and to the smallness of the profits made
No answer which can be said to be in any measure adequate can be given to the question of unreasonableness by considering these two matters alone
Their Lordships are of the opinion that the statute by the words used while making sure that losses and smallness of profits are never lost sight of requires all matters relevant to the question of unreasonableness to be considered
Capital losses if established would be one of them
 With great respect we entirely agree with this view
The contrary view unduly restricts the discretion of the Income tax Officer and compels him to hold a particular dividend reasonable though in fact it may be unreasonable
The expression smallness of profit came under the judicial scrutiny of this Court in Commissioner of Income tax Bombay City vs Bipinchandra Maganlal  Co Ltd1 Therein Shah J speaking for the Court observed thus Smallness of the profit in section 23A has to be adjudged in the light of commercial principles and not in the light of total receipts actual or fictional
This view appears to have been taken by the High Courts in India without any dissentient opinion
 The learned Judge laid down the following test Whether it would be unreasonable to distribute a larger dividend is to be judged in the light of the profits of the year in question
 If the assessable income was the test and if the commercial profits are small the learned Judge pointed out the company would have to fall back either upon its reserves or upon its capital which in law it could not do
This decision is binding on us and no further citation in this regard is called for
These two concepts accounting profits and assessable profits are distinct
In arriving at the assessable profits the Income tax Officer may disallow many expenses actually incurred by the assessee and in computing his income he may include many items on notional basis
But the commercial or accounting profits are the actual profits earned by an assessee calculated on commercial principles
Therefore the words smallness of profit in the section refer to actual accounting profits in comparison with the assessable profits of the year
Another incidental question is whether for the purpose of ascertaining the net commercial profits the tax estimated or the tax actually assessed shall be deducted
In a case where an Income tax Officer takes action under section 23A of the Act before the tax for the relevant period is assessed only the estimated tax can be deduct 1  296 pN4SCI 446 ed but there is no reason why when the tax had already been assessed before he takes action under this section the estimated tax and not the real tax shall be deducted therefrom
In this view in the present case to ascertain the commercial profits what should be deducted is not the tax shown in the balance sheet but the actual tax assessed on the income of the Company
Another question raised is whether the balance sheet is final and both the parties are precluded from questioning its correctness in any respect
There is no provision in the Income tax Act which makes the balance sheet final for the purpose of section 23A of the Act or even for the assessment
It no doubt affords a prima facie proof of the financial position of the company on the date when the dividend was declared
But nothing prevents the parties in a suitable case to establish by cogent evidence that certain items were either by mistake or by design inflated or deflated or that there were some omissions
It does not also preclude the assessee from proving that the estimate in regard to certain items has turned out to be wrong and placing the actual figures before the Income tax Officer
But in this case no attempt was made before the Tribunal to canvass the correctness of the figures either on the debit side or on the credit side and we do not think we are justified to give another opportunity to either of the parties in this regard
Before the Tribunal there was no dispute that the actual tax assessed for the relevant year was much higher than the estimated tax shown in the balance sheet
Section 23A of the Act is in the nature of a penal provision
In the circumstances mentioned therein the entire undistributed portion of the assessable income of the Company is deemed to be distributed as dividends
Therefore the Revenue has strictly to comply with the conditions laid down thereunder
The burden therefore lies upon the Revenue to prove that the conditions laid down thereunder were satisfied before the order was made see Thomas Fattorini Lancashire Ltd vs Inland Revenue Commissioners1
In the present case the Revenue failed to discharge the said burden indeed the facts established stamp the order of the Income tax Officer as unreasonable
The assessment orders passed by the Income tax Officer are not before the Court
The balance sheet shows a net profit of Rs 12811275 whereas the Income tax Officer has computed the assessable income at Rs 266766 which was later reduced in appeal by Rs 80925
There is no evidence on the record that the real commercial profits were artificially reduced in the balance
sheet
Nor is there evidence to show what part of the income assessed represents commercial profits and what part the notional income
In the circumstances it must be assumed that the amount mentioned in the balance sheet correctly represented the commercial profits
1 LR 1942 AC643
447 From the figures already extracted at an earlier stage it is manifest that the net commercial profit was barely Rs 4000 and it is not possible to hold that it was not unreasonable for the Income tax Officer to make an order to the effect that the additional sum of Rs 64000 should be deemed to have been distributed as dividends amongst the shareholders
In the result we hold that the order of the High Court is correct and dismiss the appeal with costs
Appeal dismissed


Summary:
As the dividend declared to be distributed by the respondentcompany at its General Body Meeting was below 60 per cent of the profits available for distribution the Income Tax Officer with the previous approval of the Inspecting Assistant Commissioner passed an order under section 23 A of the Income Tax Act directing that a certain higher amount shall be deemed to have been distributed as dividends as on the date of the annual general meeting of the Company
He found that having regard to the profits earned in the earlier years and the capital and taxation reserves payment of larger dividend would not be unreasonable
This was affirmed on assessees appeals by the Appellate Assistant Commissioner and the Income tax Appellate Tribunal
The Tribunal referred the question to the High Court under sec
661 of the Act which concluded that having regard to the smallness of the profits the order of the Income tax Officer was not justified and answered the question in the assessee s favour
In appeal by certificate
HELD Section 23A of the Income tax Act is in the nature of a penal provision
In the circumstances mentioned therein the entire undistributed portion of the assessable income of the company is deemed to be distributed as dividends
Therefore the Revenue has strictly to comply with the conditions laid down thereunder
The burden therefore was upon the Revenue to prove that the conditions laid down thereunder were satisfied before the order was made
Thomas Fattorini Lancashire Ltd vs Inland Revenue Commis sion applied
In the present case the Revenue failed to discharge the said burden indeed the facts established stamp the order of the Income tax Officer as unreasonable 446F G Though the object of the section is to prevent evasion of tax the provision must be worked not from the stand Point of the tax collector but from that of a businessman
The reasonableness or the unreasonableness of the amount distributed as dividends is judged by business considerations such as the previous losses the present profits the availability of surplus money and the reasonable requirements of the future and similar others
It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income tax Officer
It depends upon the facts of each case
The only guidance is his capacity to put himself in the position of a prudent businessman
It is difficult to say that the Income tax Officer cannot take into consideration any circumstances other than losses and smallness of profits
This argument ignores the expression having regard to that precedes the said words in section 23A of the Act
444B E 440 Commissioner of Income tax vs Williamson Diamond Ltd LR  applied
Sir Kasturchand Ltd vs Commissioner of Income tax Bombay City  referred to
The words smallness of profit in section 23A of the Act refer to actual accounting profits in comparison with the assessable profits of the year
The two concepts accounting profits and assessable profits are distinct
In arriving at the assessable profits the Income tax Officer may disallow many expenses actually incurred by the assessee and in computing his income he may include many items on notional basis
But the commercial or accounting profits are the actual profits earned by an assessee calculated on commercial principles
445F H Commissioner of Income tax Bombay City vs Bipinchandra Maganlal and Co Ltd 196141 ITR 296 followed
In a case where an Income tax Officer takes action under section 23A of the Act before the tax for the relevant period is assessed only the estimated tax can be deducted but there is no reason why when the tax had already been assessed before he takes action under this section
the estimated tax and not the real tax shall be deducted therefrom
445H 446B There is no provision in the Income tax Act which makes the Balance Sheet final for the purpose of section 23A of the Act or even for the assessment
It no doubt affords a prima facie proof of the financial position of the company on the date when the dividend was declared
But nothing prevents the parties in a suitable case to establish by cogent evidence that certain items were either by mistake or by design inflated or deflated or that there were some omissions
446B D