1967 (7) TMI 48 - HC - Income Tax

Summary

Issues Involved:
1. Validity of the order under section 23A of the Indian Income-tax Act, 1922.
2. Taxability of deemed dividend declared outside the taxable territory.
3. Applicability of Explanation 3 to section 4(1) of the Indian Income-tax Act.
4. Relevance of the assessee's residency status at the time of deemed dividend distribution.
5. Impact of the cash system of accounting on deemed dividend assessment.

Detailed Analysis:

1. Validity of the Order under Section 23A:
The assessee contended that the order under section 23A was invalid because M. M. Ispahani Ltd. was a non-resident company on the deemed date of the dividend declaration. The Appellate Assistant Commissioner overruled this objection, stating that during the assessment year 1947-48, the company was an Indian company, thus attracting the provisions of section 23A.

2. Taxability of Deemed Dividend Declared Outside the Taxable Territory:
The assessee argued that the dividend was declared in Chittagong, part of Pakistan, and hence outside the taxable territory. The Appellate Assistant Commissioner, however, cited Explanation 3 to section 4(1), stating that dividends paid by an Indian company without the taxable territories are deemed to be income accruing in the taxable territories if paid out of profits subjected to Indian income-tax. He directed the Income-tax Officer to tax only the proportionate dividends pertaining to profits taxable in India.

3. Applicability of Explanation 3 to Section 4(1):
The Tribunal upheld the Appellate Assistant Commissioner's interpretation, noting that the deemed dividend is taxable in the hands of the non-resident shareholder to the extent it is paid out of profits subjected to Indian income-tax. The Tribunal rejected the argument that the dividend declared by a foreign company should not be taxed in India, emphasizing the notional nature of deemed dividends.

4. Relevance of the Assessee's Residency Status:
The Tribunal rejected the assessee's claim that his non-residency status at the time of deemed dividend receipt exempted him from tax. The Tribunal held that the relevant period for taxability was when the company earned the profits, during which the assessee was a resident in India.

5. Impact of the Cash System of Accounting:
The Tribunal dismissed the argument that deemed dividends should only be assessed when received under the cash system of accounting. It clarified that the system of accountancy is irrelevant for notional income like deemed dividends.

Conclusion:
The High Court found the arguments on behalf of the assessee to be substantial. It noted that the deemed dividend was declared by a foreign company in a foreign country when neither the company nor the assessee was within the taxable territory. The Court held that these facts do not attract the provisions of section 23A. Additionally, the Court determined that Explanation 3 to section 4(1) did not apply because the dividend was not paid by an Indian company. Therefore, the question was answered in the negative, favoring the assessee.

Final Judgment:
The High Court answered the question in the negative, ruling in favor of the assessee. The Commissioner of Income-tax was directed to pay the costs of the reference to the assessee.