Appeal No 761 of 1957
Appeal by special leave from the judgment and order dated February 24 1955 of the former Bombay High Court in ITR 48X of 1954
Hardayal Hardy and D Gupta for the appellant
N A Palkhivala and I N Shroff for the respondent
November 17
The Judgment of the Court was delivered by SHAH J
The Income Tax Appellate Tribunal Bombay Bench A referred under section 661 of the Indian Income Tax Act 1922 hereinafter referred to as the Act the following question Whether the sum of Rs 15608 should have been included in the assessee Company s profit for the purpose of determining whether the payment of a larger dividend than that declared by it would be unreasonable  The High Court answered the question in the negative
Against the order of the High Court with special leave under article 136 of the Constitution this appeal is preferred
Ms Bipinchandra Maganlal  Co Ltd hereinafter referred to as the Company is registered under the Indian Companies Act The Company is one in 495 which the public are not substantially interested within the meaning of section 23A Explanation of the Act
Its paid up capital at the material time was Rs 20800 made up as follows 20 shares of Rs 50 each fully paid up and 1980 shares of Rs 50 each Rs 10 being paid up per share
In December 1945 the Company purchased certain machinery for Rs 89000 and sold it sometime in March 1947 for the price for which it was originally purchased
In the books of account of the Company the written down value of the machinery in the year of account 1946 47 April 1 1946 to March 31 1947 was Rs 73392
The trading profits of the Company as disclosed by its books of account for the year 194647 were Rs 33245
At the General Meeting held on October 21 1947
the Company declared a dividend of Rs 12000 for the year of account
In assessing tax for the year of assessment 1947 48 the Income Tax Officer computed the assessable income of the Company for the year of account 1946 47 at Rs 48761 after adding back to the profit of Rs 33245 returned by the Company Rs 15608 realised in excess of the written down value of the machinery sold in March 1947
The Income Tax Officer passed an order under section 23A of the Act that Rs 15429 being the undistributed portion of the assessable income of the Company as reduced by taxes payable shall be deemed to have been distributed as dividend amongst the shareholders as at the date of the General Meeting and the proportionate share of each shareholder shall be included in his total income
Appeals preferred against his order to the Appellate Assistant Commissioner and the Income Tax Appellate Tribunal proved unsuccessful but the Appellate Tribunal at the instance of the Company referred the question set out hereinbefore to the High Court at Bombay under a 661 of the Act
Section 23A1 of the Act as it stood at the relevant time in so far as it is material was as follows Where the Income Tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company upto the end 496 of the sixth month after its accounts for that previous year are laid before the company in general meeting are less than 60 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 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 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 share holders as at the date of the general meeting aforesaid  
Clearly by section 23A the Income Tax Officer 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 shareholders if he is satisfied that i the company has not distributed 60 of its assessable income of the previous year reduced by the Income tax and super tax payable ii unless payment of a dividend or a larger dividend than that declared having regard to a losses incurred by the company in the earlier years or b the smallness of the profits made in the previous year be unreasonable
The total assessable income of the Company for the year of account was Rs 48761 and the tax payable thereon was Rs 21332 60 of Rs 27249 assessable income reduced by the income tax and super tax due exceeded the dividend declared by Rs 4458
The first condition to the exercise of jurisdiction by the Income Tax Officer under section 23A was therefore indisputably fulfilled
But the Income Tax Officer had 497 still to be satisfied whether having regard to the smallness of the profit there is no evidence in this case that loss was incurred by the Company in earlier years it would be unreasonable to distribute dividend larger than the dividend actually declared
The Income Tax Officer did not expressly consider this question he rested his decision on the rejection of the contention raised by the Company that the difference between the price of the machinery realised by sale and the written down value in the year of account could not be taken into account in passing an order under section 23A
He it seems assumed that if that difference be taken into account distribution of larger dividend was not unreasonable and the Tribunal proceeded upon the footing that the assumption was correctly made
Counsel for the Revenue submits in support of the appeal that the expression  smallness of profit  means no more than smallness of the assessable income and that in any event in the computation of profits the amount realised by sale of the machinery in the year of account in excess of its written down value was liable to be included in considering whether the condition relating to smallness of profit was fulfilled
At the material time section 26C of the Act defined income as inclusive amongst others of any sum deemed to be profits under the second proviso to cl
vii of sub section
2 of section 10
By section 10 in the computation of profits or gains of an assessee under the head Profits and gains of business profession or vocation carried on by him the amount by which the written down value of any building machinery or plant which has been sold discarded or demolished
or destroyed exceeds the amount for which the building machinery or plant is actually sold or its scrap value is to be allowed as a deduction
This allowance is however subject to an exception prescribed by the second proviso to el
vii sub section
2 of section 10 that where the amount for which any building machinery or plant is sold exceeds the written down value so much of the 63 498 excess as does not exceed the difference between the original cost and the written down value shall be deemed to be profit of the previous year in which the sale took place
In computing the profits and gains of the Company under section 10 of the Act for the purpose of assessing the taxable income the difference between the written down value of the machinery in the year of account and the price at which it was sold the price not being in excess of the original cost was to be deemed to be profit in the year of account and being such profit it was liable to be included in the assessable income in the year of assessment
But this is the result of a fiction introduced by the Act
What in truth is a capital return is by a fiction regarded for the purposes of the Act as income
Because this difference between the price realized and the written
down value is made chargeable to income tax its character is not altered and it is not converted into the assessee s business profits
It does not reach the assessee as his profits it reaches him as part of the capital invested by him the fiction created by section 102vii second proviso notwithstanding
The reason for introducing this fiction appears to be this
Where in the previous years by the depreciation allowance the taxable income is reduced for those years and ultimately the asset fetches on sale an amount exceeding the written down value ie the original cost less depreciation allowance the Revenue is justified in taking back what it had allowed in recoupment against wear and tear because in fact the depreciation did not result
But the reason of the rule does not alter the real character of the receipt
Again it is the accumulated depreciation over a number of years which is regarded as income of the year in which the asset is sold
The difference between the written down value of an asset and the price realized by sale thereof though not profit earned in the conduct of the business of the assessee is nationally regarded as profit in the year in which the asset is sold for the purpose of taking back what had been allowed in the earlier years
A company normally distributes dividends out of its business profits and not out of its assessable income
499 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 section 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
For instance in the case of companies receiving income from property even though tax is levied under section 9 of the Act on the bona fide annual value of the property the actual receipts may be considerably less than the annual value and if the test of reasonableness is the extent of the assessable income and not the commercial profit there may frequently arise cases in which companies may have to sell off their income producing assets
The Legislature has deliberately used the expression smallness of profit and not smallness of assessable income and there is nothing in the context in which the expression smallness of profit occurs which justifies equation of the expression profit with assessable income
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 500 opinion see Sir Kasturchand Ltd vs Commissioner of Income Tax Bombay City 1 Ezra Proprietary Estates Ltd vs Commissioner of Income Tax West Bengal 2 and Commissioner of income Tax Bombay City vs F L Smith  Co Bombay Ltd 3
By the fiction in section 102vii second proviso read with section 26C what is really not income is for the purpose of computation of assessable income made taxable income but on that account it does not become commercial profit and if it is not commercial profit it is not liable to be taken into account in assessing whether in view of the smallness of profits a larger dividend would be unreasonable
In our judgment the High Court was right in holding that the amount of Rs 15608 was not liable to be taken into account in considering whether having regard to the smallness of the profit made by the Company it would be unreasonable to declare a larger dividend
The appeal therefore fails and is dismissed with costs
Appeal dismissed
1 1940 XVII ITR 493
2 1950 XVIII ITR 762
3 1959 XXXV ITR 183


Summary:
Prior to January 26 1950 when the erstwhile State of Hyderabad merged in the Union of India and became a Part B State the respondent company was assessed to income tax under the Hyderabad Income tax Act by which depreciation allowance was given to it on the basis of the written down value of its assets such as buildings machinery plants etc in accordance with cl
C of section 125 of that Act which provided that in the case of assets acquired before the previous year and before the commencement of the Act the written down value would be the actual cost to the assessee less 1 depreciation at the rates applicable to the assets calculated on the actual costs for the first year since acquisition and for the next year on the actual cost diminished by the depreciation allowance for one year and so on for each year upto the commencement of that Act and ii depreciation actually allowed to the assessee on such assets for each financial year after the commencement of the Act
After the merger of Hyderabad with the Union of India by sections 3 and 13 of the Finance Act 950 the taxation laws in force in the State were repealed and the Indian Income tax Act 1922 was extended to that area and in exercise of the powers conferred by section 12 of the Finance Act 1950 the Central Government issued a notification dated December 2 1950 called the Taxation Laws Part B States Removal of Difficulties Order 1950
Paragraph 2 of the Order provided that  in making any assessment under the Indian Income tax A ct 1922 all depreciation actually allowed under any laws or rules of a Part B State shall be taken into account in computing the aggregate depreciation allowance referred to in proviso c to section 102vi and the written down value under section 105b of the said Act 
For the assessment year 1951 52 the respondent was assessed for the first time under the Indian Income tax Act and basing its claim on para
2 of the aforesaid Order it asked for 319 the value thereof at their inception and deducting therefrom such depreciation as was allowed for the three assessment years in which it was assessed under the Hyderabad Income tax Act
7 By order dated November 30 1951 the Income tax Officer disallowed the respondent s claim on the ground that it was against the principle inherent in granting depreciation allowance which must decrease from year to year
The matter was taken up to the Supreme Court and while it was pending there on May 8 1956 the Central Government issued a notification in exercise of its powers conferred on it by section 12 of the Finance Act 1950 whereby an explanation was added to the aforesaid para
2 as follows For the purpose of this paragraph the expression all depreciation actually allowed under any laws or rules of a Part B State  means and shall be deemed to have always meant the aggregate allowance for depreciation taken into account in computing the written down value under any laws or rules of a Part B State or carried forward under the said laws or rules
 The respondent challenged the validity of the notification of 1956 and also its applicability to the present case on the grounds 1 that it was ultra vires the powers conferred on the Central Government by section 12 of the Finance Act 1950 2 that it contravened article 14 of the Constitution and 3 that in any case it could have no retrospective effect
Held  1 that the true scope and effect of section 12 was that it was for the Central Government to determine if any difficulty of the nature indicated in the section had arisen and then to make such order or give such direction as appeared to it to be necessary to remove the difficulty the legislature having left the matter to the executive
Pandit Banarsi Das Bhanot v The State of Madhya Pradesh and Others   relied on
In the present case a difficulty had arisen because if depreciation actually allowed under the Hyderabad Income tax Act was taken into account in computing the aggregate depre ciation allowance and the written down value an anomalous result would follow namely depreciation allowance to be allowed to the assessee in the accounting year under the Indian Income tax Act would be more than what was allowed in previous years under the Hyderabad Income tax Act
Consequently the Central Government was within its power under section 12 in making the notification dated May 8 1956
2 that the notification of 1956 applied to all those to whom para
2 of the Taxation Laws Part B States Removal of Difficulties Order 1950 was applicable and created no unequal treatment of persons in the like situation
Accordingly the notification did not contravene article 14 of the Constitution
3 that the Central Government had the power under section 12 of the Finance Act 1950 to make an order or give a direction so as to remove difficulties which arose in the very beginning 320 and therefore the notification though added in 1956 was valid and was applicable to the assessment of 1951 52