1978 (5) TMI 24 - HC - Income Tax

Summary

Issues Involved:
1. Whether capital gains form part of the assessee's business profits for the purpose of section 23A of the I.T. Act, 1922.
2. The appropriateness of the application of section 23A by the Income Tax Officer (ITO).

Issue-wise Detailed Analysis:

1. Capital Gains as Part of Business Profits:
The primary issue in this case was whether the capital gains amounting to Rs. 1,35,808 should be considered part of the assessee's business profits for the application of section 23A of the I.T. Act, 1922. The assessee argued that these capital gains were not part of its commercial profits and were shown in the accounts as a capital reserve. The ITO, however, did not accept this contention, holding that there was no prohibition in the company's memorandum or articles against distributing such gains as dividends. The ITO thus included the capital gains in the distributable surplus and levied additional super-tax on the undistributed amount.

2. Application of Section 23A by the ITO:
The ITO's decision was challenged on appeal to the Appellate Assistant Commissioner (AAC) and then to the Tribunal. The AAC upheld the ITO's decision, construing that the definition of dividend was wide enough to include capital gains. The Tribunal, however, considered the law as laid down by the Supreme Court in CIT v. Bipinchandra Maganlal & Co. and CIT v. Gangadhar Banerjee & Co. (Pvt.) Ltd., and concluded that capital gains should not be distributed as dividends except under special circumstances. The Tribunal noted that the capital gains had been credited to reserves and surplus and not to the profit and loss account, thus holding that it would not be prudent business practice to distribute such gains as dividends. Consequently, the Tribunal set aside the ITO's order under section 23A.

Judgment:
The High Court was asked to determine whether the Tribunal was correct in holding that the capital gains did not form part of the assessee's business profits and that the order under section 23A was not justified. The court considered various authoritative texts and case laws, including decisions from the Supreme Court and other High Courts, which discussed the treatment of capital gains in the context of distributable profits and dividends.

The court agreed with the Tribunal's view that capital gains, being notional or deemed income, should not be equated with commercial profits. It was noted that while a company could choose to distribute capital gains as dividends, it was not compulsory. The court emphasized that the decision to treat capital gains as part of the company's profits and include them in the distributable surplus was at the discretion of the company's directors. If the directors chose to channel the entire surplus into reserves, the ITO could not mandate that it be treated as profits.

The court concluded that in the present case, since the entire amount of capital gains was put into reserves and not brought back into the profit and loss account, it could not be treated as part of the business profits for determining the reasonableness of the dividend declared. Thus, the question referred was answered in the affirmative and in favor of the assessee, indicating that the Tribunal was correct in its decision.

Separate Judgments:
The judgment was concurred by both judges, with C.K. Banerji J. explicitly agreeing with the decision.

Conclusion:
The High Court ruled that capital gains do not form part of the assessee's business profits for the purpose of section 23A of the I.T. Act, 1922, and upheld the Tribunal's decision to set aside the ITO's order. The judgment emphasized the distinction between commercial profits and notional gains, reinforcing the principle that the treatment of capital gains for dividend distribution is at the discretion of the company's directors.