1988 (4) TMI 110 - AT - Income Tax

Summary

Issues Involved:
1. Classification of the assessee company as a manufacturing or investment company.
2. Applicability of Section 104 of the Income Tax Act.
3. Adequacy of profits and resources for declaring dividends.

Detailed Analysis:

1. Classification of the Assessee Company:
The primary issue in this case is whether the assessee company can be regarded as a company engaged in the manufacture or processing of goods or as an investment company. The Income Tax Officer (ITO) treated the assessee company as an investment company, while the assessee contended that it was engaged in the manufacture or processing of goods or mining. The ITO's classification was based on the fact that the income from manufacturing activities was reduced to nil due to the set-off of brought forward losses and unabsorbed depreciation, leaving only the income from other sources, which led to the classification as an investment company.

2. Applicability of Section 104 of the Income Tax Act:
Section 104 of the Income Tax Act deals with the distribution of profits as dividends. The ITO issued a notice under Section 104, arguing that since the income from manufacturing activities was reduced to nil, the remaining income from other sources necessitated treating the assessee as an investment company. The assessee objected, arguing that its substantial income from manufacturing should be considered, notwithstanding the set-off of losses. The Commissioner (Appeals) confirmed the ITO's assessment, stating that the gross total income, as defined in Section 104, did not include any income from manufacturing activities due to the set-off of losses, thereby supporting the ITO's classification.

3. Adequacy of Profits and Resources for Declaring Dividends:
The assessee argued that it could not declare dividends due to the smallness of profits and past losses. However, the Commissioner (Appeals) noted that the company had substantial general reserves of Rs. 25 lakhs, indicating that the company had adequate resources to declare dividends. The ITO computed the distributable income and determined that 90% of this income should have been distributed as dividends. Since no dividend was declared, the ITO levied a tax of 50% under Section 104(1)(a).

Judgment:
The Tribunal examined the applicability of Section 104 and the definition of "gross total income" under Section 109(iv). It was noted that the gross total income should be computed before making any deductions under Chapter VI-A. The Tribunal concluded that the income from manufacturing activities, which was reduced to nil due to the set-off of losses, could not be included in the gross total income. Therefore, the assessee company could not be regarded as a company engaged mainly in manufacturing or processing of goods or mining for the relevant previous year.

The Tribunal also noted that the expression "for the relevant previous year" in the Explanation to Section 104 indicates that the composition of income must be assessed annually. If the income from manufacturing activities is less than 51% of the total income for a given year, the company would be subject to the provisions of Section 104.

Regarding the adequacy of profits, the Tribunal found that the company had substantial reserves and a positive liquid position, which contradicted the assessee's claim of inadequate resources. Therefore, the authorities below correctly applied the provisions of Section 104, except for the rate of tax.

Conclusion:
The appeal was allowed in part, with the Tribunal affirming the classification of the assessee as an investment company for the relevant year and the applicability of Section 104, while adjusting the rate of tax applicable.