2003 (3) TMI 4 - SC - Income Tax

Undistributed Profits - Assessee is a company registered carrying on business in agricultural activities and dairy farming. The assessee was subjected to levy of income-tax under section 104 of the Income-tax Act, for its failure to distribute the required statutory percentage of dividend - that there was nothing unreasonable in the decision of the board of directors not to distribute dividends from the compensation awarded but to capitalise it in a reserve account.

Issues Involved:
1. Whether the capital gains of Rs. 7,45,109 could be considered for purposes of computing the distributable income of the assessee-company for the purposes of section 104 of the Income-tax Act, 1961.
2. Whether the Tribunal was right in canceling the orders passed by the Income-tax Officer under section 104 of the Act for the two assessment years 1974-75 and 1975-76.
3. Whether the Income-tax Officer can act as a "super director" and override the business decisions of the company's board of directors regarding the distribution of dividends.

Detailed Analysis:

Issue 1: Capital Gains Consideration for Distributable Income
The primary contention was whether the capital gains amounting to Rs. 7,45,109, received as compensation for the compulsory acquisition of agricultural land, should be included in the "distributable income" for the purpose of section 104 of the Income-tax Act, 1961.

The court noted that the capital gains arose before March 1, 1970, due to the compulsory acquisition of agricultural land in 1962. Section 47(viii) of the Act exempts any transfer of agricultural land in India effected before March 1, 1970, from the scope of section 45. Consequently, the compensation received was not part of the "total income" as defined in section 2(45) of the Act and could not be included in the "gross total income" under section 109(iv). Therefore, it did not form part of the "distributable income" under section 104.

The High Court had earlier held that capital gains were part of the assessable income, following precedents like Cardamom Marketing Company (Travancore) Ltd. v. CIT and CIT v. South India Corporation P. Ltd. However, the Supreme Court clarified that these judgments did not address the specific exclusion of agricultural land from capital gains tax.

Issue 2: Tribunal's Decision to Cancel Income-tax Officer's Orders
The Tribunal had provided full relief to the appellant by holding that the provisions of section 104 could not be invoked by the Income-tax Officer for the assessment years 1974-75 and 1975-76. The High Court, however, reversed this decision.

The Supreme Court upheld the Tribunal's decision, reiterating that the capital gains from the compulsory acquisition of agricultural land were exempt from tax and did not form part of the "distributable income." Hence, the orders passed by the Income-tax Officer under section 104 were invalid.

Issue 3: Income-tax Officer as "Super Director"
The appellant argued that the Income-tax Officer should not act as a "super director" and override the business decisions of the company's board of directors regarding dividend distribution, especially considering past losses and the need to stabilize finances.

The Supreme Court agreed, emphasizing that the Income-tax Officer's jurisdiction under section 104 is conditional upon two satisfactions: (1) profits and gains distributed as dividends are less than the statutory percentage, and (2) considering past losses or smallness of profits, distributing dividends would be unreasonable. The court cited CIT v. Asiatic Textiles Ltd., which stated that the Income-tax Officer cannot act as a "super director."

The court further referenced CIT v. Gangadhar Banerjee and Co. (P.) Ltd., which held that the reasonableness of dividend distribution should be judged from a business perspective, considering factors like past losses, current profits, and future financial needs.

The Supreme Court concluded that the board of directors' decision to capitalize the compensation in a reserve account, given the company's accumulated losses and loss of its only asset, was reasonable. Therefore, the Income-tax Officer could not override this decision.

Conclusion:
The Supreme Court set aside the High Court's judgment and upheld the Tribunal's order for the assessment years 1974-75, 1975-76, and 1976-77. The questions raised were answered in favor of the assessee and against the Revenue, with no order as to costs.

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