1965 (3) TMI 20 - SC - Income Tax

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 of section 23A of the Indian Income-tax Act, 1922 and the application of section 23A of the Indian Income-tax Act was in accordance with law ? Held that - The High Court correctly held that the Tribunal went wrong in taking into consideration the past profits instead of the past losses, the taxation reserves without consideration of 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. Appeal dismissed.

Issues Involved:
1. Construction of Section 23A of the Indian Income-tax Act, 1922.
2. Determination of "smallness of profit" for the purpose of dividend distribution.
3. Validity of the balance-sheet as a basis for assessing commercial profits.
4. Burden of proof on the revenue to justify the application of Section 23A.

Issue-wise Detailed Analysis:

1. Construction of Section 23A of the Indian Income-tax Act, 1922:
The appeal raised the question of interpreting Section 23A of the Indian Income-tax Act, 1922, before its amendment by the Finance Act, 1955. The section is divided into three parts: defining the jurisdiction of the Income-tax Officer, prescribing the manner of exercising jurisdiction, and providing for the assessment of statutory dividends in the hands of shareholders. The section aims to prevent the exploitation of a private company's juristic personality for evading higher taxation. The Income-tax Officer must be satisfied that dividends distributed are less than 60% of the assessable income, reduced by income-tax and super-tax. If this condition is met, the Officer may declare the undistributed portion as deemed dividends, but must also consider whether the payment of a larger dividend would be unreasonable due to losses or smallness of profits.

2. Determination of "smallness of profit" for the purpose of dividend distribution:
The term "smallness of profit" must be understood in light of commercial principles, not merely assessable income. The court emphasized that the Income-tax Officer should act as a prudent businessman, considering factors such as previous losses, present profits, surplus money, and future requirements. The assessment should be based on commercial or accounting profits, not just assessable income. The court referenced the Judicial Committee's view in Commissioner of Income Tax v. Williamson Diamonds Ltd., agreeing that all relevant factors must be considered, not just losses and smallness of profits.

3. Validity of the balance-sheet as a basis for assessing commercial profits:
The balance-sheet is not final for the purposes of Section 23A or even for assessment. It provides prima facie proof of the company's financial position but can be contested with cogent evidence showing inaccuracies or changes in estimates. In this case, the balance-sheet showed a net profit of Rs. 1,28,112-7-5, while the Income-tax Officer computed assessable income at Rs. 2,66,766, later reduced by Rs. 80,925. The court found no evidence that commercial profits were artificially reduced, thus assuming the balance-sheet correctly represented commercial profits.

4. Burden of proof on the revenue to justify the application of Section 23A:
Section 23A is penal in nature, requiring strict compliance with its conditions. The burden lies on the revenue to prove these conditions were met. The court noted that the revenue failed to discharge this burden, as the facts indicated the Income-tax Officer's order was unreasonable. The balance-sheet indicated a net commercial profit of only Rs. 4,000, making it unreasonable to deem an additional Rs. 64,000 as distributed dividends.

Conclusion:
The court held that the order of the High Court was correct, dismissing the appeal with costs. The judgment emphasizes the necessity for the Income-tax Officer to act reasonably and consider all relevant factors, ensuring that commercial profits, not just assessable income, guide the determination of dividend distribution under Section 23A.

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