Full Judgment Text
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 6
CASE NO.:
Appeal (civil) 7525-7527 of 2001
PETITIONER:
DELHI FARMING AND CONSTRUCTION (P) LTD.
RESPONDENT:
COMMISSIONER OF INCOME TAX, DELHI
DATE OF JUDGMENT: 26/03/2003
BENCH:
RUMA PAL & B.N. SRIKRISHNA
JUDGMENT:
JUDGMENT
2003(3) SCR 35
The Judgment of the Court was delivered by
SRIKRISHNA, J. The assessee is a company registered under the provisions of
the Companies Act and carrying on business in agricultural activities and
dairy farming. The assessee was subjected to levy of income-tax under
section 104 of the Income Tax Act, 1961 (’the Act’) for the assessment
years 1974-75, 1975-76 and 1976-77, for its failure to distribute the
required statutory percentage of dividend during the concerned previous
years ending on 31st March 1973. 31st March 1974 and 31st March 1975,
respectively.
The figures of total income-tax assessed and the distributable surplus as
computed by the Income-tax Officer for the assessment years 1974-75 and
1975-76, are as under:
___________________________________________________________________________
_________
Assessment year 1974-75 1975-76
1 Total income assessed Rs. 3,22,580 Rs.
72.130
2 Less taxes payable thereon Rs. 2,20,160 Rs.
49,228
3 Distributable surplus Rs. 1,02,420
Rs.22,902
4 Dividends that ought to Rs. 92,223 Rs.
20,612 have been declared by the company, i.e. 90%
5 Dividend declared by Nil
Nil the assessee company
6 Debit balance in profit Rs. 91,472
Rs.20,508 and loss account
7 Capital reserve shown in Rs.7,45,109
Rs.7,45,109 the balance-sheet
___________________________________________________________________________
________
The petitioner’s business of agricultural activities had resulted in losses
year after year and the accumulated losses at the commencement of the year
1974-75 was Rs. 3,93,610 and for the year 1975-76 the loss was Rs. 91,472.
During the year 1962 certain agricultural land belonging to the appellant
company was compulsorily acquired. There was a long drawn litigation with
regard to the compensation payable to the appellant. The appellant was
awarded a sum of Rs. 7,64,787 as compensation towards the acquired land on
which an amount of Rs. 2,94,844 became payable as interest. This amount of
interest was paid on different dates during February 1973. Since the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 6
compensation was payable immediately upon acquisition of the land, the
appellant-assessee took the view that the interest earned on the
compensation had to be apportioned over the years 1962 to 1972. A sum of
Rs. 20,357.91 only was credited as interest for the period ending 31st
March, 1973 and the balance was credited towards the earlier periods. The
compensation amount of Rs. 7,45,109.72, being capital gain on the land
compulsorily acquired by the Government, was transferred to capital reserve
and shown as such in the balance sheet.
The Directors of the appellant company took the view that there was no
possibility of distributing dividend in the concerned three accounting
years on account of the past losses including the loss of the only asset of
the company i.e. agricultural land. It was, therefore, thought prudent to
capitalize the compensation amount in a capital reserve account and not
fritter it away by distribution of dividend.
For the financial year ending 30.6.1973 the Income-tax Officer assessed the
income as Rs. 3,22,580 and for the financial year ending 30th June, 1974
the total income was assessed at Rs.72,130. Since the appellant had not
declared any dividend during the aforesaid accounting years, the Income-tax
Officer issued notices to the appellant under section 104 of the Act for
the assessment years 1974-75 and 1975-76. The appellant contended that,
because of the past accumulated losses and the smallness of the profit for
the current year payment of any dividend would have been unreasonable, and,
therefore, it had decided not to fritter away the money available in its
hand as compensation. The Income-tax Officer, however, disagreed and took
the view that there was sufficient money in the hands of the appellant
which could and ought to have been declared as dividend. He was also of
view that the appellant was an investment company and there was substantial
capital available as reflected in the capital reserve of Rs. 7,45,109. He
also held that such a huge capital reserve was not required by the company
for the purpose of any business requirement. Consequently, the Income-tax
Officer held that the appellant was liable to additional income-tax of 50%
of the profit available, which was fixed at Rs.51,210 for the year 1974-75
and Rs. 11,451 for the year 1975-76.
The appeals filed by the appellant before the Appellate Commissioner of the
Income Tax were rejected by upholding the orders of the Income-tax Officer.
Further appeals to the Income Tax Appellate Tribunal resulted in full
relief to the appellant as the Tribunal agreed with the contentions of the
appellant and held that the provisions of section 104 of the Act could not
be invoked by the Income-tax Officer in both the assessment years i.e.
1974-75 and 1975-76. At the instance of Revenue a reference was made under
section 256(1) of the Income Tax Act, 1961 to the High Court of the
following questions of law :
" 1. Whether on the facts, and in the circumstances of the case, the
Tribunal was right in law in holding that the capital gains of Rs. 7,45,109
could not be considered for purposes of computing the distributable income
of the assessee-company for the purposes of section 104 of the Income Tax
Act, 1961, and
(2) If the answer to the first question is in the negative, whether the
Tribunal was right in cancelling the orders passed by the Income-Tax
Officer, u/s 104 of the Act for the two assessment years 1974-75 and
1975-76 ?"
By a common judgment dated 25.5.2001 the High Court answered both the
questions against the assessee and in favour of the Revenue and also
disposed of another reference pertaining to assessment year 1976-77, by
taking the same view.
Hence, these three appeals.
Section 104 of the Act at the material time read as under:
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 6
"S.104. Super-tax on undistributed income of certain companies:-
(1) Subject to the provisions of sub-section (2) and of Sections 105,
106 and 107, 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 distributable
income of the company of that previous year, the Income-tax Officer shall
make an order in writing that the company shall, apart from the sum
determined as payable by it on the basis of the assessment under Section
143 or Section 144, be liable to pay super-tax at the rate of-
(a) fifty per cent, in the case of an investment company.
(b) thirty-seven per cent, in the case of a trading company, and
(c) twenty-five per cent, in the case of any other company.
(2) The Income-tax Officer shall not make an order under sub-section
(1), if 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 within the
period of twelve months referred to in sub-section (1), would be
unreasonable; or
(ii) that the payment of a dividend or a larger dividend than that declared
within the period of twelve months referred to in sub-section (1) would not
have resulted in a benefit to the revenue; or
(iii) that at least seventy- five per cent of the share capital of the
company is throughout the previous year beneficially held by an institution
or fund established in India for a charitable purpose the income from
dividend whereof is exempt under Section 11."
The statutory percent of dividend distributable, is prescribed at different
rates in the clause (iii) of Section 109 of the Act. The expression ’gross
total income’ is defined in clause (iv) of section 109 as "total income as
computed in accordance with provisions of the Act". Section 2(45) of the
Act defines ’total income’ as the total amount of income referred to in
Section 5, computed in the manner laid down in the Act. There is no doubt
that capital gains falling within section 45 of the Act would be chargeable
to income-tax under the head "capital gains" and in the manner indicated in
the fasciculus of sections 45 to 55A.
The learned counsel for the appellant urged the following contentions in
support of the appeal :
(a) That the sale proceeds of agricultural land are totally exempt from the
charge of tax under section 45 of the Act by reason of section 47(viii);
hence, the capital gains accruing as a result of the compensation paid
could never have formed part of the "total income" of the appellant-
assessee;
(b) That capital gains are not commercial or business profits, nor are they
income in the true sense of the term, although by legislative fiction they
have been included within the scope of ’income’ and made subject to tax;
(c) In any event, the Income-tax Officer cannot act as a super director and
sit in appeal over the business decision taken by the Board of Directors of
the appellant company not to distribute dividend during the relevant
assessment years having regard to the past losses, the meagerness of the
profits made in the relevant years and the necessity to stabilize the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 6
finances of the company.
For the Revenue, the learned counsel joins issue on all the three
contentions and supports the view taken by the High Court as fully
justified on principle and precedents.
Dealing with the first contention urged by learned senior advocate for the
appellant, it appears to us that both the Revenue authorities and the High
Court have missed the thrust of the argument. The capital gains arose prior
to 1st day of March, 1970, and, they arose not because of any transfer
voluntarily made by the appellant-company, but by reason of the compulsory
acquisition of agricultural land belonging to the assessee. Even assuming
that compulsory acquisition of land is a transfer of a capital asset within
the meaning of section 45 of the Act, section 47 (viii) specifically
exempts any transfer of agricultural land in India effected before the 1s’
day of March, 1970 from the scope of section 45 of the Act. Thus, the
compensation which became payable to the appellant as a result of the
acquisition of its agricultural land in 1962, was totally exempt from
section 45. Consequently, it did not amount to ’income’ within the scope of
section 2(24)(vi) as there was no ’capital gain’ within the meaning of
section 45. It was also not to be included while computing the total income
of the appellant as defined in section 2(45) of the Act. Thus, the amount
of compensation received by the appellant could not have formed part of the
"gross total income" within the meaning of clause (iv) of Section 109 of
the Act. Consequently, there was no question of its becoming part of
"distributable income" as defined in section 109(1). We are hence, of the
view that the appellant must succeed on its first contention that the
entire amount of capital gains which accrued as a result of acquisition
(and hence compulsory transfer) of the agricultural land could not have
been subjected to tax under section 104 of the Act as it was wholly
exempted from capital gains and not part of the ’gross income’ or the
distributable income for the purpose of section 104 of the Act.
The High Court rejected the contention of the appellant-assessee by
emphasising that the capital gain was part of assessable income of the
assessee, following the view taken by other High Courts as in Cardamom
Marketing company (TRAV), Ltd. v. Commissioner of Income Tax, (1986) 158
ITR 621 and Commissioner of Income Tax v. South India Corporation Ltd.,
(1990) 183 ITR 361 (Ker). The High Court was persuaded to hold that if such
losses as are referred to in clause (d) are deductible from the gross total
income, there is no scope for entertaining a doubt that capital gains form
part of the gross total income of the company within the meaning of section
109 of the Act.
We are afraid that the point has been entirely missed. In neither judgment
of the Kerala High Court relied upon was there advertence as to what would
happen if the capital asset transferred was agricultural land. In Cardamom
case (supra) the only argument urged was that capital gains were not part
of the business profits, and therefore, could not be taken into account in
reckoning the distributable income. This contention was rejected by the
Kerala High Court by pointing out that section 109(i), while defining
"distributable income", specifically takes in and includes the gross total
income of the company as reduced by, inter alia, losses under the head
"capital gains" relating to the capital assets, other than short term
capital assets.
On the second contention, as to whether capital gains, not being commercial
profits in the strict sense, could be treated as part of the gross total
income for the purpose of distribution of dividends, there is apparent
divergence of opinion amongst the High Courts.
In CIT v. Gannon Dunkerley and Co. Ltd., (1971) 79 ITR 637 the Bombay High
Court was of the view that capital gains are made only accidentally and
occasionally and in making such gains an assessee cannot be described as
indulging in business activity and commerce. In inflationary market and/or
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 6
rising market old and worn out capital assets required to be disposed of
may on sale fetch better values and yet are required to be replaced by
similar kinds of capital assets. Under normal circumstances, therefore, the
High Court found it difficult to accept the submission that according to
the commercial principles the amount received as capital gains are profits
intended to be distributed amongst the share-holders. In ordinary
circumstances, directors of business experience would never distribute
amounts received by way of capital gains. These amounts would ordinarily be
reserved for the purpose of replacement of the assets sold so as to carry
on the business of the concerned company in normal manner. For the same
reason, amount earned as capital gain was considered to be notional
profits. The availability of these gains in the hands of a company did not
render these gains commercial profits.
The Calcutta High Court in CIT v. N. Guin and Co. (P) Ltd., (1979) 116 ITR
475, while deciding the case under section 23A of the Income Tax Act, 1922,
held :
"In our view, when a company disposes of any of its capital asset and
realises a price higher than its cost price resulting in a surplus then it
will be for the directors to decide if such surplus would be treated as
part of the profit of the company and included in distributable surplus. If
the directors of the company decide to treat the capital gains as part of
the profits of the company and the amount is put back in the profit and
loss account, and thereafter if only a part of such gains is distributed as
dividend, it would be open to the ITO to go into the question whether a
greater proportion of such gains should have been distributed. This would
be an exceptional case, But where the entire surplus is channelled into
reserves it is not for the ITO to lay down that it should have been treated
as profits."
In Factors (P) Ltd. v. Commissioner of Income-Tax, Madras, (1975) 98 1TR
105, a case arising under section 23A of the Act of 1922, it was held by
the Madras High Court that whether the capital gain in a particular case is
to be treated as profit available for distribution under section 23A or a
capital return would depend on the facts and circumstances of each case. In
certain cases capital gain would be in the nature of 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, it was held
that the Revenue would be justified in considering the amounts received by
way of capital gains as forming part of the profits of an assessee while
exercising the powers under section 23 A of the 1922 Act.
In our view, there is really no conflict of opinion amongst the decisions
of the High Courts. The consensus appears to be that there cannot be a hard
and fast rule that capital gains ought or ought not to be treated as
commercial or business profits on which dividends could be distributed. It
would ultimately depend on the facts and circumstances of each case based
upon which the Board of Directors take a commercial decision as to whether
dividend should be distributed thereupon or not. In any event, it appears
to us that nothing turns on the second contention as far as the present
appeals are concerned.
The third contention urged by the appellant-assessee is equally formidable.
The High Court in the impugned judgment seems to have assumed that the
moment the Income-tax Officer is satisfied in respect of any previous year
that the profits and gains distributed as dividends by any company within
12 months immediately following the expiry of that previous year are less
than the statutory percentage of the distributable income of the company of
that previous year, an order in terms of section 104 must necessarily be
passed. In our view, the jurisdiction of the Income-tax Officer under
Section 104 is hedged in by two prerequisite satisfaction on his part.
First, that profits and gains are distributed at less than the statutory
percentage of distributable income; second, that having regard to the
losses incurred by the company in earlier years, or due to the smallness of
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 6
the profits made in the previous year, the payment of dividend or a larger
dividend than that declared would be unreasonable. The second satisfaction,
in our view, brings in business considerations. As this Court observed in
Commissioner of Income-Tax (Central), Calcutta v. Asiatic Textiles Ltd,
(1971) 82 ITR 816, while discussing a case under section 23 A of the 1922
Act, it is not open for the Income-tax Officer to constitute himself as a
’super-director’ in this regard.
In CIT v. Bipinchandra Maganlal & Co., (1961) 41 ITR 290 this Court pointed
out that the legislature has deliberately used the expression "smallness of
profits" and not "smallness of the assessable income" and there is nothing
in the context which would require equation of the expression "profit" with
"assessable income". Smallness of the profit in section 23A has to be
adjudged in the light of commercial principles and not in the light of
total receipts, actual or fictional. It was also pointed out that a company
normally distributes dividends out of its business profits and not out its
assessable income. There is no definable relation between the assessable
income and the profits of a business concern in a commercial sense.
In CIT v. Gangadhar Banerjee and Co. (1965) 57 ITR 176 this Court, while
dealing with the corresponding provision under the 1922 Act, held :
"The Income-tax Officer, acting under this section is not assessing any
income to tax: that will be assessed in the hands of the shareholder. He
only does what the directors should have done. He puts himself in the place
of the directors. Though the object of the section is to prevent evasion of
tax, the provision must be worked not from the standpoint of the tax
collector but from that of a businessman. The yardstick is that of a
prudent businessman. The reasonableness or the unreasonableness of the
amount distributed as dividends is judged by business considerations, such
as the previous losses, the present profits, the availability of surplus
money and the reasonable requirements of the future and similar others. He
must take an overall picture of the financial position of the business".
The words "having regard to" used in the section do not restrict the
consideration only to two matters indicated in the section as it is
impossible to arrive at a conclusion as to reasonableness by considering
only the two matters mentioned isolated from other relevant factors. It is
neither possible nor advisable to lay down any decisive tests for the
guidance of the Income-Tax Officer. The satisfaction depends upon the facts
of each case. The only guidance is his capacity to put himself in the
position of a prudent businessman or the director of a company and his
sympathetic and objective approach to the difficult problem that arises in
each case. The question which the Income-tax Officer was to ask himself
was: Whether the Board of Directors of the appellant company, in deciding
to transfer to capital reserve the entire amount of the, awarded
compensation and not distributing dividends therefrom, had acted
unreasonably or as unreasonable businessman? Taken against the background
of the accumulated losses of the company over several financial years,
together with the loss of the only asset of the company, we are of the view
that there was nothing unreasonable in the decision of the Board of
Directors not to. distribute dividends from the compensation awarded but to
capitalize it in a reserve account. In our judgment, the second statutorily
required satisfaction could not have been arrived at by the Income-tax
Officer so as to exercise jurisdiction under Section 104 of the Act. The
third contention also succeeds.
In the result, we set aside the judgment of the High Court and uphold the
order of the Income Tax Appellate Tribunal for the years 1974-75, 1975-76
and 1976-77 and answer the questions raised in favour of the assessee and
against the Revenue. There shall be no order as to costs.