FACTORS P LIMITED Vs. COMMISSIONER OF INCOME TAX

JUDGEMENT

(1.) THE assessee is a private limited company. It carries on various activities like insurance agents, transport contractors, etc. Its share capital is 50 ordinary shares of 1,000 each and paid up capital is Rs. 500 per share amounting to Rs. 25,000. For the assessment year 1961-62 corresponding to the year ending 30th June, I960, the company suffered a loss on transport contracts in the sum of Rs. 8,519. During this period it had sold certain shares held by it in other companies which resulted in a profit of Rs. 35,826. This was transferred to the profit and loss account of the company and the net profit was arrived at Rs. 29,177'97. After providing for taxation, a sum of Rs. 20,000 was transferred to the general reserve. This account stood at Rs. 30,000 as on 30th June, 1960. Cash and bank balance as on that date was Rs. 16,770.19. No dividend was 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 23 A 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 treated as profit available for distribution. THE Appellate Assistant Commissioner did not accept these contentions of the assessee and upheld the order oi the Income-tax Officer, In support of his decision he relied on the decision of the Supreme Court in Commissioner of Income-tax v. Gangadhar Banerjee and Company P. Ltd., . THE assessee appealed to the Tribunal. THE Tribunal referred to the capital position as well as the reserve built up by the assessee-company as shown in its balance-sheet as on 30th June, 1960, and the cash position on that date and considered that any declaration of dividend would not be out of capital. Ultimately, the Tribunal also held that having regard to the commercial profits of the assessee it would not have been unreasonable to have declared a dividend and that, therefore, the provisions of Section 23A were rightly invoked in this case. At the instance of the assessee the following question of law has been referred :

(2.) THE earliest case that is referred to in this connection is the one in Wall v. London and Provincial Trust Ltd., [1920] l Ch 45(Ch D). 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 investments for others of the like nature, and (b) to borrow on debenture stock and to redeem or pay off any moneys so borrowed. THE company was formed on the double account system and the business accounts were conducted and kept as required by the articles of association on the footing that profit or loss on a change of investment was carried to capital account and net receipts over expenditure were carried to revenue account and became available for payment of dividends without regard to any depreciation in the market value of the company's investments. In 1900 the company issued certain debentures at par. In 1918, owing to the general fall in the value of securities, the company was able to redeem some of its debentures at a discount. THE investments forming the assets of the company had also fallen to an extent approximately equivalent to the discount at which the debenture stock had been redeemed. THE directors claimed the right to carry the whole of the amount of this discount to revenue account. THE plaintiff, on behalf of himself and other preferential shareholders in the company, sued for a declaration that it was beyond the powers of the directors and in contravention of the articles of association to transfer to the revenue account the sums representing the discounts arising upon redemption of the company's debentures. While disposing of a motion for interlocutory injunction, Younger J. considered the issues in detail. Rejecting the contention of the company, the learned Lord Justice held that clause 3(b) of the memorandum of association did not authorise a separate and independent business, but was a subsidiary to the main purpose in clause 3(a) and that the amount of discount at which the debenture stock had been redeemed was not net profit of the company or profit arising from its business and that no part thereof could be distributed as dividend. It should be noted that the company is a trust investment company which means that the capital and revenue accounts shall be kept separate. THE articles of the company, which were extracted in the reports, provided that :