COMMISSIONER OF INCOME-TAX, BOMBAY CITY I, BOMBAY vs. JUBILEE MILLS LTD. BOMBAY
What did the Supreme Court hold?
The Supreme Court held that the view taken by the Appellate Tribunal was erroneous in law, and the High Court had rightly answered the question in favour of the respondent-company. The Court reasoned that Section 23-A(1) does not exclude losses incurred prior to reconstruction from consideration; it requires the Income-tax Officer to consider 'losses incurred by the company in the earlier years'. The Court clarified that 'profits' under Section 23-A(1) refer to commercial or accounting profits, not assessable income. While a company that has overcome past losses through capital adjustment might theoretically be in a position to distribute its entire profits, it cannot be deemed unreasonable if it retains a portion to build capital reserves and regain financial strength. The Tribunal erred by holding prior losses irrelevant simply because they were adjusted against capital. The Court also directed that, in accordance with Section 66(5), the Tribunal must now dispose of the case by rehearing the respondent and the Commissioner in light of the High Court's judgment, the evidence, and according to law.
What were the facts?
The respondent company, Jubilee Mills Ltd., had suffered significant losses prior to 1930. In 1930, it reconstructed its capital by writing off Rs. 12,75,000 from its profit and loss account against its paid-up capital, reducing the face value of its shares. For the assessment year 1948-49, the company declared a dividend of Rs. 24,750. The Income-tax Officer, considering the company liable to declare a much larger dividend under Section 23-A of the Income-tax Act, 1922, deemed a dividend of Rs. 3,98,798. The Appellate Assistant Commissioner and the Income-tax Appellate Tribunal dismissed the company's appeals, holding that losses prior to reconstruction were irrelevant for determining the reasonableness of dividend declaration under Section 23-A. The High Court, on reference, held that prior losses were relevant.
What were the issues?
1. Whether losses incurred by the company prior to its capital reconstruction in 1930 are relevant for determining the reasonableness of the company not declaring a larger dividend in the assessment year 1948-49, as prescribed by Section 23-A of the Income-tax Act, 1922? (Question of law) Assessee's contention: The company argued that past losses, even if adjusted against capital, were relevant to the company's financial position and thus its ability to declare a larger dividend. They contended that it was not unreasonable to retain profits for rebuilding capital strength. Revenue's contention: The revenue, as represented by the Income-tax Officer and upheld by the Appellate Tribunal, argued that after capital reconstruction, the company emerged with a new, reduced capital, and only this reconstructed capital should be considered for Section 23-A purposes, rendering prior losses irrelevant. The Tribunal relied on its own reasoning that adjusted losses were no longer outstanding. 2. What procedure should the Income-tax Appellate Tribunal follow after the High Court decides a question of law against the Tribunal's view, under Section 66(5) of the Income-tax Act, 1922? (Question of procedure/law) This issue arises from the High Court's decision and the subsequent directions given by the Supreme Court.
Which sections of the Income-tax Act were involved?
Section 23-A, Section 66(5)
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Cause title — parties, addresses and appearances
stated as follows in the course of its order: "It is true that company incurred large losses in past years. But it reconstructed its capital in 1930. In that year, the debit balance in the profit and loss account had been set off against the paid-up capital thereby re- ducing the paid-up capital of the company. After the reconstruction, the company emerged in a new cloak _of reduced capital. For the purpose of determining the applicability of provision of Section 23A, in our view, the reconstructed capital alone has to be taken into account and not the original cap;tal. a great portion of which had been wiped out by debiting losses. Those prior losses had already been wiped out by writing off against the paid up capital. They cannot now be taken for consideration." At the instance of the respondent-company thy Appellate Tribunal referred the following questions of law for the opinion of the Bombay High Court :
542 SUPREME COURT REPORTS [1968] 2 SC.R. . .. I. Whether on the facts and in the circumstances ot the ca1e, the Income-tall Officer was competent to pas, an 01der u/s. 23(1) of the Act after having allow- ed a rebate of one aana per rupee in the assessment under t.he proviso (a) to paragraph (B) of Part I of the Second Schedule of the Finance Act, 1948 ?
If the answer to question No. I is in the affirma- tive whether on the facts and in the circumstances of the c~se, the asscssel'. company is a company in which the pubhc are substantially interested for the purposes of sec. 23A of the Act '' and 3. Whether the loss of Rs. 12.75.000/- incurred by the company prior to its reconstruction in 1930, could be taken into consideration for purposes of the appli- cability of sec. 23A (1) of the Act ?" By its judgment dated March 13, 195.8 the High Court answered the first question in the affirmative, holding that the Income-tax Officer was competent tu pass an order under s. 23A(l) and he was not precluded from doing so by reason of his having granted rebate to the respondent-company. On the second qt1estion also the High Court gave its answer in the affirmative, holding that the respondent.company was a company in which the public was >Ubstantially interested for the purpose of s. 23A of the Act. In view of the answer to the second question the provisions of s. 23A of the Act would not be applicable to the respondent-company and the third question hecame academic, and the High Court declined to answer it. The CommL<;.sioner of Income-Tax took the matter in appeal to this Court which reversed the answer which the High Court had given to question No. 2 and held that the respondent- company was a company in which the public were not substan- tially interested for the purpose of s. 23A of the Act. In view of the decision of this Court on the second question it became neces- sary for the High Court to consider the third question and this Court therefore remanded the reference fo the High Court for con- sideration of the third question. After the remand the High Court heard the reference again and by its judgment dated May 3 / 4, 1963 answered the third question in the affirmative and in favour of the respondent-company. It was held by the High Court that the losses prior to reconstruction of the respondent-«impany in 1930 which were set off against the paid-up capital could be taken into consideration for the purpose of application of s. 23A of the Act. Section 23A of the Act before its amendment in 1955, in so far as it is material, states as follows: "23A. Power to assess individual members of certain companies- A. B c 0 E F G H
A B c D E F G H C.l.T. v. JUBILEE MILLS (Ramaswaml, !.) 543 ( 1) where the income-tax officer is satisfied that in respect of any previous year the profits and gains dis- tributed as dividends by any company upto the end of the sixth month after its accounts for that previous year are laid before the company in general meeting are less than sixty per cent of the assessable income of the com- pany of that previous year, as.reduced by the amount of the income-tax and super-tax payable by the company in respect thereof he shall, unless he is satisfied that having regard to losses incurred by the company in earlier years or to the smallness of the profit made, the payment of a dividend or a larger dividend than that declared would be unreasonable, make with the previous approval of the Inspecling Assistant Commissioner an order in writing that the undistributed portion of the assessable income of the company of that previous year as com- puted for income-tax purposes and reduced by the amount of income-tax and super-tax payable by the company in respect thereof shall be deemed to have been distributed as dividend amongst the shareholders as at the date of the general meeting aforesaid and thereupon the proportionate share thereof of each share- holder shall be included in the total income of such shareholder for the purpose of assessing bis total income : Provided further that this sub-section shall not apply to any company in which -the public are substantially interested or to a subsidiary company of such a com- pany if the whole of the share capital of such subsidiary company is held by the parent company or by the nominees thereof. Exp/anation.-For the purpose of this sub-section, a company shall be deemed to be a company in which the public are substantially interested ·if shares of the company (not being shares entitled to a fixed rate of dividend, whether with or without a further right to participate in profits) carrying not less than twenty-five per cent of the voting power have been allot- ted unconditionally to. or acquired unconditionally by, and are at the end of the previous year beneficially held by the public (not including a company to which the pro- visions of this sub-section apply). and if any such shares have in the course of such previous year been the subject
SUPREME COURT REPORTS [ 1968] 2 S.C.J.. of dealings in any stock exchange in the taxable terri- tories or arc in fact freely transferable by the holders to other members of the public." The applicability of s. 23A of the Act is therefore attracted when it is found that the company in which the public are not substantially interested has declared a dividend of less than 60% of the assessable income of the company as reduced by the amount of income-tax and super-tax payable by the company in respect thereof for any previous year. The section, however, has provided that even if the applicability of the section is attracted, the Incomc- tax Officer has to consider whether, having regard to the losses incurred by the company in earlier years or having regard to the smallness of its profits, it would have been unreasonable for the company .to declare. a dividend larger than which it had actually declared .. The object of the section is to collect super-tax from the shar.eholders which would be payable if the company had dis- tributed its income by way of dividends and to discourage avoid- ance of •;ix by failing to distribute its income. On behalf of the appellant Mr. B. Sen put forward the· argu- ment that as a result of the reconstruction of the capital in 1930 a new chapter had opened in the life of the respondent-company and losses which it had suffered prior to the reconstruction of its capital were irrelevant and should not be considered for the pur- pose of s. 23A of the Act so.far as subsequent years are concerned. It was said that for determining the application of s. 23A of tho Act it was the reconstructed capital alone and not the original capital that had to be taken into account. It was PO;!lted out that though the reduction of 'he capital h3d been necessitated by lesses ouffered, the reconstruction of the capital had resulted in wiping out the losses and star·ini! the company afresh with reduced capital as its paid-up share c.apital. The argument was stressed that where the company adjusts losses against the paid-up capital and reconstructs its capital, the financial position of the company and its dividend distributing capacity in subsequen! years have to be judged only by the result of its tradin~ after reconstruct;on and not with reference 10 earlier losses which have disappeared by ad- justment. In our opinion. there is no warrant for the acgument put forward on behalf of the appellant. There is nothing in the langua!!e or con•ext of s. 23A (I) of the Act to suggest that the expression "losses incurred in the earlier years" should be construed so as to ex- clude losse~ incurred.prior to the reconstruction and to include only unadjusted or carried forward losses still outstanding in the books of the company. In our opinion, the losses which have been ad- justed in the books of the company at the time of reconstruction do not cease to be "losses incurred hy the company in the earlier years" within the meaning of s. 23A ( 1). The section requires A I! c D E F G II ,_
A B c D E F G H C.l.T, .v .. JU.l!ILEE MILLS (Ramaswami, J.) 545 the Income-tax Officer to take into consideration "the losses in, curred by the company in the earlier years" or "the smallness of profits made." It is well-established that the profits which are to be considered under s. 23A(l) are the commercial or the account- ing profits and not the assessable income or the asse.ssable profits of the company, because it is the commercial or the actual accounting profits . which are to form the source from which the dividend is to be distributed and not the assessable income or assessable profits which may have no relation to the commercial or accounting profits and which are not the actual source out of which the dividend could be paid.-See C.l.T., West Bengal v. Gangadhar Banerjee('). On a similar line of reasoning the consideration of losses in the earlier years should be made in the setting and conte/(t of the inquiry whether the company could be regarded as acting reasonably in declaring a smaller dividend. It is true that as a result of the losses having been adjusted against the paid-up capital they no longer remain as unadjusted losses or carried for)Vard losses but it does not mean that they cease to have any i.p1pact on the financial position of the company in sub- sequent yetti;s. Even if the company resorts to the method of wiping out the losses by adjusting them against its capital, the procedure results in crippling its finances and the company in future.)'ears may reasonably take steps for improving its crippled financial position. If therefore a company which has got over its losses for some years by adjusting them against its capital and reducing its capital makes a profit in the subsequent year it may theoretically be in a position to distribult> the whole of its profits for that year but it cannot be said to have acted unreasonably if it chose not to do so and retained a portion of the profits for the purpose of building up a capital reserve which in course of time u1ould enable the company to regain its original strength of capital which had been crippled by the adjustment of losses at the time of reconstruction. We are therefore unable to accept the argu- ment put forward on behalf of the ·appellant on this aspect of the case. In our opinion, the Appellate Tribunal mis-directed itself in law in holding .that the losses incurrecj. prior to the reconstruc- tion of the respondent-company are irrelevant far the purpose of application c•f s. 23A of the Act in subsequent years. As we have already said, the losses incurred prior to the reconstruction hav- ing been adjusted are no longer shown in the books of the com- pany. It does not, however, mean that the losses cease to have their effect on the financial posftion of the company in subsequent years. It cannot therefore be said .that the losses prior to recon- struction do not fall within the ambit of the expre>sion "losses in- curred by the company in earlier years" for the purpose of the application of s. 23A of the Act. Such losses are relevant to be considered even though they may not be surviving in the books of (1) 57 LT. R. 176. L2Sup Cl/68-4
5~6 SUPREME COURT REPORTS (1968] 2 S.C.R. the C-Ompany as un_adjusted or carried forward losses. It may be A that even after talong s_uch losses into e-0nsideration it is possible to come to the conclusion that the company was not justified in not declarin~ a larger dividend than that. actually declared. But what the Tnbunal has done in this case is that it has refused to take such losses into account at all because it has taken the view that by their adjustment against the capital the losses do not sur- B \"!Ve for coqsideration for the purpose of the application of s. 23A of the Act. The view taken by the Appel!a•e Tribunal is erro- neous in law and we arc of opinion that the High Coun has right- ly answered the third question in the affirmative and in favour of the respondent-company. But it is necessary to give certain effective directions, so that a mere order of dismissal of this appeal may not result in injustice. Section 66(5) of -the Act requires the Tribunal on receiving · a copy of the judgment of the High Court to pass such orders as are necessary to dispose of the case conformably to such judg- ment. The section clearly imposes an obligation upon the Tribunal to dispose of the appeal in the light of and conformably with the judgment of the High Court. If the High Court agrees ~ith the .,iew of the Tribunal, the appeal may be di5posed of by a formal order. But if the High Court disagrees with the Tribunal on a ques!ion of law, the Appellate Tr'bunal must modify its order in the light of the order of the High Court. If for example the High Court has held that the judgment of the Tribunal is vitiated, because it is based on no evidence or because the judgment pro- ceeds upon a mis-cons•ruction of the statute, the Appellate Tribunal would be under a duty to dispose of the case confonn- ably with the opinion of the High Court and on the merits of the dispute; and rehear the appeal after giving notice to the parties and redetermine ir in accordance with law. In Income-tax Appel- late 1'riburw/. Bc>mbay and Ors. v. S. C. Camba/la and Co. Ud., (') the Bombay High Court explained the procedure to be followed JS under : "when a reference is made lo the H;l!h Court either under s. 66 (I ) or section 66 (2) the decision of the Appellate Tribunal cannot be looked upon as final; in other wQrds. the appeal i5 not finally dispooed of. It is only when the High Coun decide<: the case, exercises its advi~;ory juri iction, and gives directions to the Tri- bunal on questions of law. and lhe Tribuna1 reconsiders the matter and decides it, tha• the aope~l is finally disposed of. ......... it is clear that what the Appel- late Tribunal is doing after the High Court has heard the case is to exercise its appellate powers under section (I) 29 I.T.R. t IS c D E F G JI I• ,
A B c D C.I.T. v. JUBILEE MILLS (Ramaswaml, /.) 547 33 ........... The shape that the appeal would ulti- mately take and the decision that the Appellate Tri- bunal would ultimately give would entirely depend upon the view taken by the High Court." This passage was quoted with approval by this Court in Esthuri Aswathiah v. The C.1.T., Mysore('). In the present case, the High Court has held, and we agree with the High Court, that fte judgment of the Appellate Tribunal is vitiated in law because it has proceeded on an erroneous interpretation of the statute. The High Court accorwngly answered the third question in the affirma- tive and in favour of the respondent-company. We must make it clear that the answer of the High Court to this question mean• that the Appellate Tribunal must now, in conformity with the judgment of the High Court, act under s. 66 ( 5) of the Act, that is to say, dispose of the case after rehearing the respondent- · company and the Commissioner in the light of the evidence and according to law. Subject to this wrection. the appeal is dismissed with costs. R.K.P.S. Appeal dismissed. (I) Civil Appeal No. 631 of '!~66. decided on April 18, 1967.
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