COMMISSIONER OF INCOME TAX Vs. NARASIMHAN G

JUDGEMENT

(1.) TWO questions have been referred to this court by the Income-tax Appellate Tribunal, Madras Bench, for the opinion of this court. The questions read as follows :

(2.) THE year of assessment is 1963-64, the corresponding accounting period ending on 31st March, 1963. THE questions referred to us arise from the following facts:

(3.) SECTION 194 casts an obligation on the part of the company, inter alia, to deduct the tax payable by the shareholder when amounts are lent or paid which would fall under SECTION 2(22)(e), the deemed dividend being limited to the extent of the accumulated profits. Deduction can be made only if the company can determine at the time of payment the extent of the accumulated profits. With reference to SECTION 205 of the Companies Act, it was stressed that a company cannot pay dividend out of its capital assets. The will of the legislature having been embodied in SECTION 194 of the Act and SECTION 205 of the Companies Act, it was stated that the cumulative effect of these statutory provisions was to make any deemed dividend under SECTION 2(22)(e) also flow out of the accumulated profits of the company. At any rate, that is the only legal way of paying dividend as envisaged by SECTION 2(22)(e) and it must be taken that they have been so paid by the assessee unless for other purposes it is established that there has been a contravention of the law. As a result of this position under the law, Mr. V. K. Thiruvenkata-chari, counsel for the assessee, contended that the effect of SECTION 2(22)(e) when read with SECTION 194 of the Act and SECTION 205 of the Companies Act is to make the deemed dividend under SECTION 2(22)(e) as well flow out of the accumulated profits ; and this being so, these payments cannot be ignored for the purpose of reckoning the value of the accumulated profits. The argument is attractive, and we are not able to discern any flaw in this reasoning. No doubt, a fiction should not be extended beyond its limits though it must be given its full effect. SECTION 2(22)(e) does not in terms provide that what has been deemed as dividend should be deemed to have come from accumulated profits. But in SECTION 2(22)(e) there is an indication that the deemed dividend is not unconnected with the accumulated profits. In fact, there is a clear provision that the deeming provision will attach only to that part of the amount paid which is represented by the accumulated profits of the company. When this provision is read with the language of the section which provides for deduction of tax on such dividend and also read with the statutory restriction of payment of dividend out of the capital assets, it is reasonable to come to the conclusion that a dividend would and should come out of the accumulated profits. The sum of Rs. 64,517 must, therefore, be taken as having come out of the profits of the previous year and since it has not been contended or established that there have been deductions made from accumulated profits in the past when dividend was issued or loans made the same has to be deducted from the accumulated profits of Rs. 3,01,331. Even deemed dividend under the I.T. Act, we conceive, cannot be paid out of the capital and once the law is such that certain payments must be deemed to be payments of dividend, for all purposes it has to be treated as dividend and the restriction that the payment of dividend should not be from capital will attach to such payment as well. The view which we are inclined to take is supported by the decision of the Bombay High Court in C1T v. P.K. Badiani [1970] 76 ITR 369. This decision has been relied on by the Tribunal and, we think, rightly. There is an elaborate discussion of the question in its various aspects in that decision. We, therefore, agree with the view taken by the Tribunal and answer the first question referred to us in the affirmative, i.e., in favour of the assessee and against the revenue.