1970 (2) TMI 31 - HC - Income Tax

Assessee is a limited liability company to which the provisions of section 23A of the Indian Income-tax Act, 1922, were admmittedly applicable - whether capital gains should be taken into consideration in determining whether a company s profits were sufficient to declare dividends

Summary

Issues Involved:
1. Whether capital gains amounting to Rs. 4,62,974 were includible in the commercial profits for the purpose of considering 'the smallness of the profits made' under section 23A of the Indian Income-tax Act, 1922.

Detailed Analysis:

Issue 1: Inclusion of Capital Gains in Commercial Profits under Section 23A

The core issue revolves around whether the capital gains of Rs. 4,62,974 should be considered part of the commercial profits for determining the 'smallness of the profits made' under section 23A of the Indian Income-tax Act, 1922.

Relevant Facts:
- The respondent assessee-company sold its Madras branch, resulting in capital gains of Rs. 4,62,974.
- The profits of the Madras branch for a specific period were agreed to belong to the purchaser firm.
- For the assessment year 1947-48, the capital gains and branch profits were included in the company's income for tax computation.
- The company's profit and loss account disclosed commercial profit at Rs. 45,861, but the Income-tax Officer assessed the income at Rs. 9,92,007 after disallowances and inclusions.

Income-tax Officer's Decision:
- The Income-tax Officer included the capital gains in the commercial profits for determining the 'distributable surplus' under section 23A.
- The assessee-company's contention that capital gains should be excluded was rejected.

Appellate Tribunal's Decision:
- The Tribunal upheld the assessee-company's contention that capital gains are not commercial profits.
- It emphasized that capital gains, though taxable, are not commercial profits and should not be included in the profit and loss account.
- Consequently, it set aside the Income-tax Officer's order under section 23A.

Legal Arguments:
- Revenue's Argument: Capital gains are actual profits and should be considered commercial or accounting profits. These profits are includible in the 'distributable surplus' and can be distributed as dividends.
- Assessee's Argument: Capital gains do not increase commercial profits. The object of section 23A is to compel distribution of profits based on commercial accounting principles, distinguishing between capital and revenue income.

Judicial Precedents:
- Commissioner of Income-tax v. Bipinchandra Maganlal & Co.: The Supreme Court held that capital gains are not commercial profits but are taxable by fiction. The character of the capital gains as business profits is not altered by their taxability.
- Commissioner of Income-tax v. Gangadhar Banerjee & Co.: The court emphasized that the 'smallness of profit' should be judged by commercial principles, not by total receipts, actual or fictional.

Court's Analysis:
- The court noted that the phrase 'income' in the Income-tax Act connotes a periodical monetary return from definite sources, distinguishing revenue receipts from casual returns.
- Historically, capital gains were not subject to tax until 1946 and were treated differently from business profits.
- The court found it difficult to accept that capital gains should be considered commercial profits for distribution among shareholders.
- It emphasized that capital gains are accidental and occasional, and in normal business practice, such gains are reserved for asset replacement rather than distribution.

Conclusion:
- The court concluded that capital gains do not form part of the commercial profits for the purpose of section 23A.
- The Income-tax Officer must base his order on actual commercial profits, not on capital gains.

Final Judgment:
- The court answered the question in the negative, indicating that capital gains should not be included in the commercial profits for considering 'the smallness of the profits made' under section 23A.
- The applicant was ordered to pay costs.

Question Answered in the Negative.