1975 (3) TMI 15 - HC - Income Tax

Summary

Issues Involved:
1. Applicability of Section 23A of the Indian Income-tax Act, 1922.
2. Interpretation of "commercial profits" versus "assessable income."
3. Impact of the mercantile system of accounting on dividend income.
4. Determination of "smallness of profit" under Section 23A.

Issue-Wise Detailed Analysis:

1. Applicability of Section 23A of the Indian Income-tax Act, 1922:
The primary question was whether the amount of dividends declared in favor of the assessee should be considered by the Income-tax Officer (ITO) before passing an order under Section 23A of the Indian Income-tax Act, 1922. The assessee, an investment company, argued that the declared dividends were not received and hence should not be included in the commercial profits for the purpose of Section 23A. The ITO and the Appellate Assistant Commissioner (AAC) disagreed, while the Tribunal sided with the assessee, stating that the dividends were notional or fictional receipts and should be excluded from the commercial profit calculation.

2. Interpretation of "commercial profits" versus "assessable income":
The Tribunal and the High Court emphasized the distinction between "commercial profits" and "assessable income." Commercial profits refer to the actual profits available for distribution, while assessable income includes notional and fictional receipts. The Tribunal, supported by the Supreme Court's decisions in Commissioner of Income-tax v. Bipinchandra Maganlal & Co. Ltd. and Indra Singh & Sons Ltd. v. Commissioner of Income-tax, held that only actual commercial profits should be considered for the purpose of Section 23A.

3. Impact of the mercantile system of accounting on dividend income:
The revenue argued that under the mercantile system of accounting, dividends declared but not received should still be considered as income. The Supreme Court in Keshav Mills Ltd. v. Commissioner of Income-tax clarified that under the mercantile system, income is recognized when it accrues, not when it is received. However, the High Court noted that this principle applies to income assessment, not to the determination of commercial profits for dividend distribution under Section 23A. The court emphasized that commercial profits must be actual and available profits, not merely book entries.

4. Determination of "smallness of profit" under Section 23A:
The ITO must determine whether the profits are sufficient to justify the distribution of dividends. The Supreme Court in Commissioner of Income-tax v. Bipinchandra Maganlal & Co. Ltd. and Commissioner of Income-tax v. Gangadhar Banerjee & Co. (Private) Ltd. held that "smallness of profit" should be judged based on commercial principles, not on assessable income. The High Court reiterated that the ITO should act as a prudent director, considering actual available profits rather than notional profits. The Tribunal correctly excluded the declared but unpaid dividends from the commercial profit calculation, aligning with the Supreme Court's guidance.

Conclusion:
The High Court upheld the Tribunal's decision, answering the question in the negative and in favor of the assessee. The court emphasized that for the purpose of Section 23A, only actual commercial profits should be considered, and the mere declaration of dividends does not equate to actual receipt or availability for distribution. The court also noted that the mercantile system of accounting does not override the requirement to consider actual commercial profits for dividend distribution under Section 23A. The decision aligns with the principles laid down by the Supreme Court, ensuring that the ITO must take a holistic view of the company's financial position and act as a prudent director.