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TMI Blog1974 (7) TMI 51X X X X Extracts X X X X X X X X Extracts X X X X ..... declared by the assessee. The Income-tax Officer did not accept the assessee's working of capital gain. He computed it at Rs. 37,688 and assessed the total income at Rs. 38,965 ; the tax thereon came to Rs. 11,881 leaving a distributable surplus of Rs. 27,084. As no dividend had been declared the assessee was called upon to show cause why the provisions of section 23A of the Indian Income-tax Act, 1922, should not be invoked. In its reply dated June 15, 1964, the assessee contended that the entire income consisted of capital gains, that according to commercial principles they did not form part of the revenue profits and that, therefore, the company did not declare any dividend. It was further contended that the Companies Act, 1956, prohibited declaration of dividend out of capital gains. The Income-tax Officer rejected all these contentions and levied a sum of Rs. 10,021.08 as additional super-tax under section 23A of the Indian Income-tax Act, 1922. In the appeal before the Appellate Assistant Commissioner the assessee also contended in addition to the point raised by him before the Income-tax Officer that the realised accretion in one item of the capital asset could not be treate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot restrict the distribution of the same, they might also be distributed. However, the dividend shall not be paid out of capital even if the memorandum or articles of association authorise such payment, as that would amount to a reduction of the capital itself, which is not authorised by law. These general principles may be found stated in some of the text books. In 6 Halsbury (third edition), paragraph 774, at pages 399-400, we find the following passage : " There is nothing in the Act determining how profits available for distribution as dividends are to be reckoned. It is a question left for decision by the commercial world. Profits for this purpose may in some cases be amounts differing from what are regarded as profits for other purposes. The profits of a company are of two kinds. First, there are the profits ascertained, as already mentioned, representing the credit balance on revenue account arising from the ordinary business of the company. Secondly, there may be profits realised by dealing with the fixed capital and forming accretions to capital, as, for instance, where part of the undertaking of the company is sold, for an amount in excess of that which was paid for it, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o an annuity for the use of the railway terminable in a few years, it was held that it might distribute the annuity in dividends without making provision for replacing the lost capital. Where sufficient assets would be left to answer the paid-up capital a realised profit on capital assets can be divided unless forbidden by the constitution of the company." It would be seen from the foregoing passages that there is no prohibition for distribution of capital gains as dividend except when it is forbidden by the memorandum and articles of association. Now, let us deal with the decisions relied on by the learned counsel for the assessee. The earliest case that is referred to in this connection is the one in Wall v. London and Provincial Trust Ltd. The question for consideration in that case was whether the profit made by the company in the redemption of its debenture stock at a discount could be distributed as dividend to the shareholders. The company was a trust investment company. The objects as defined by clause 3 of its memorandum of association were (a)to acquire and hold stocks, shares and securities of the classes therein specified and from time to time change such investment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... disregarded in estimating the net profits of the company........" It is with reference to these provisions and the nature of the company, it was held that the amount of discount was not profit distributable as dividend. The following passages which deal with this question may also be quoted: "It is true, as I have said, that in the case of such a company as we have here capital and revenue accounts are distinct accounts and you may operate upon a credit balance on the second account irrespective of loss on the first. But the accounts are distinct. There is a gulf set between them not spanned by any bridge. You must not carry any asset from one to the other. The price of being entitled to distribute as dividend a revenue balance regardless of a capital loss is that you may not supplement a deficiency of revenue by carrying to the credit of that account a gain on capital however realised...... The truth is that in accounts kept as this company is required to keep its accounts, an appreciation in capital assets can never increase the dividend fund. If for the purpose of dividend a company like this desires to gain the benefit of an appreciation in capital values, it must adopt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e portion acquired. A portion of the profits, the directors proposed to treat as profits available for paying dividend to the members. On the question whether they are distributable surplus profits it was held that the company could, in the absence of a special provision to the contrary, distribute a realised profit on its capital asset. It was argued in that case that section 121 of the Companies Clauses Consolidation Act, 1845, prohibited the distribution of this profit. That section read : " The company shall not make any dividend whereby their capital stock will be, in any degree, reduced." It was held that "capital stock" there means paid up capital of the company and that provision did not prohibit a company paying a dividend out of a realised profit on its total capital assets. In Verner v. General and Commercial Investment Trust also, a passage (at page 265) to the same effect is found, which reads : " Moreover, when it is said, and said truly, that dividends are not to be paid out of capital, the word 'capital' means the money subscribed pursuant to the memorandum of association, or what is represented by that money. Accretions to that capital may be realised and tur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the company. In support of this contention, the learned counsel relied on certain decisions which generally dealt with the scope of section 23A and the principles stated therein. The relevant part of section 23A reads as follows: " Where the Income-tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company within the twelve months immediately following the expiry of that previous year are less than the statutory percentage of the total income of the company of that previous year.... the Income-tax Officer shall, unless he is satisfied. . . . (i) that, having regard to the losses incurred by the company in earlier years or to the smallness of the profits made in the previous year, the payment of a dividend or a larger dividend than that declared would be unreasonable or.... make an order in writing ......" In Commissioner of Income-tax v. Bipinchandra Maganlal and Co., with reference to the meaning to be attached to the words "smallness of the profits" in section 23A, as it then stood, it was observed: "Smallness of the profit in section 23A has to be adjudged in the light of commercial principles and not i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be included within the head "profits and gains of busines, profession or vocation". Having regard to this legislative history of "capital gain", it is difficult to hold that the capital gains also could be considered as part of the profits in connection with the exercise of the powers under section 23A. In this connection, the learned judge also relied on the position that the rate of tax on capital gains was different from the rate of tax levied under the heads of income, and that super-tax also was not payable in respect of capital gains. With great respect to the learned judges, we are unable to see how the fact that capital gains was not included for the purposes of income-tax prior to 1946 or the legislative history of the same or the rate of tax being different or the non-liability to super-tax have any bearing on the ascertainment of commercial profits of the company. If a particular income is exempt from tax, certainly it could not be said that it would not form part of the commercial profits of the company. In the later part of the judgment, the learned judges have mixed up the question whether such capital gains could be distributed with the question whether they are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le of an investment. Whether the capital gain in a particular case is to be treated as profits available for distribution under section 23A or a capital return would depend on the facts and circumstances of each case. We have already seen that unless there is an express or implied prohibition under the constitution of the company either under the memorandum or the articles, capital gains are distributable income. The profits realised on sale of such an investment or an asset is a real profit and not a fictional profit or a notional profit. The Supreme Court's decision in Commissioner of Income-tax v. BipinChandra Maganlal & Co. (already referred to) is no authority for the position that even in cases where the sale price is more than the cost price and the amount, in fact, was realised and available in the hands of the assessee, it is only notional profit and not commercial profit. It is true that in certain cases capital gain would be in the nature of a return of capital itself and in those cases they would not be considered for the purpose of applicability of section 23A. Barring such exceptional cases, we are of the view that the Income-tax Officer would be justified in consider ..... 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