S. Kumaraswami v. Income-Tax Officer, Nagercoil.

Srinivasan, J.:— The Income-tax Officer assessed the petitioner to income-tax on Rs. 2,46,510 in the assessment year 1957-58 and on Rs. 3,95,185 in the assessment year 1958-59. The petitioner applied under article 226 of the Constitution for the issue of writs of certiorari to set aside the orders of these assessments.

2. The relevant facts were as follows:

The petitioner was the managing director of Palkulam Estates (Private) Ltd. This company was in receipt of income, which was claimed to be wholly agricultural. In the year of account corresponding to the assessment year 1957-58 the petitioner borrowed sums from Palkulam Estates (Private) Ltd. He also borrowed monies from two other firms, Pioneer Works (Private) Ltd., of which also he was a managing director, and from Pioneer Motor (Private) Ltd., of which he was only a shareholder. All these were companies in which the public had no substantial interest, and they thus came within the scope of section 23A of the Income-tax Act. The amounts on which the petitioner was assessed to tax represented the total of the advances or loans taken by the petitioner from these three firms. The Income-tax Officer applied section 2(6A)(e) of the Income-tax Act and brought these sums to tax.

3. One of the objections taken by the petitioner to the assessment was that section 2(6A)(e) was invalid and inoperative. The Parliament had not the legislative competence to enact the statutory provision under which the loans which were not income in fact were deemed to be the income of the assessee. That contention was negatived by the department and by the Tribunal. It has since been held by this court in K.M.S. Lakshmana Aiyar v. Additional Income-Tax Officer [1960] 40 I.T.R 469 Mad.. that section 2(6A)(e) was not beyond the legislative competence of the Parliament, and that entry 82 in List I of Schedule VII of the Constitution conferred the requisite legislative competence on Parliament. It was also held that competence to legislate in respect of taxes on income also included a power to legislate in order to check evasion of taxes, and that it extended to such matters like taking a loan where loans were taken as a means of evading tax liability. It was pointed out in that case:

“Having regard to the devious ways which the ingenuity of man can adopt, if the Legislature raises an irrebuttable presumption, that in all cases where loans are advanced to a shareholder in a controlled company having undisbursed profits, the advances should be deemed to be income, the legislation would still be one relating to income-tax, though it may be that it operates harshly in certain cases. It may also be that in the operation of such a presumption or of a statutory fiction like the one contained in section 2(6A)(e) certain loans are taxed as income. But that is only incidental in the operation of the statute whose pith and substance is taxation of income.”

4. In view of this decision, which is authority binding on us, we have to reject the contention of the petitioner, that section 2(6A)(e) was ultra vires the Parliament and beyond its legislative competence. The attack on the constitutional validity of the deeming provision in section 2(6A)(e) therefore fails.

5. With reference to the loans taken from Palkulam Estates (Private) Ltd., the further objection was that the provisions of section 2(6A)(e) do not apply to agricultural income, and since monies in the hands of the company constituted agricultural income, they still retained the character of agricultural income when they came into the hands of the petitioner as loans.

6. For the purpose of these petitions we shall assume, without investigating the correctness of the claim or deciding it, that the income derived by the Palkulam Estates (Private) Ltd. was wholly agricultural income as defined by the Income-tax Act.

7. The learned counsel for the petitioner pointed out that agricultural income is expressly exempted from liability to income-tax by section 4(3)(viii) of the Income-tax Act. Entry 82 in List I of Schedule VII of the Constitution also excludes agricultural income from the scope of the parliamentary legislation. The further contention of the learned counsel for the petitioner is that what was agricultural income in the hands of the company continued to retain that character when it came into the hands of the petitioner as a loan, and that, therefore, it falls outside the scope of section 2(6A)(e), which can only apply to taxes on income assessable to tax under the Indian Income-tax Act. This plea raised only a question of interpretation, because the presumption is in favour of the constitutional validity of a legislative provision, and where no express provision is made to tax agricultural income, section 2(6A)(e) should be so interpreted to be consistent with its constitutional validity and exclude agricultural income from its scope.

8. The short question then is whether on the distribution of profits being effected by a company to its shareholders—whether the distribution is actual or whether it is fictional—the money in the hands of the shareholder still continues to partake of the character of the income as it was in the hands of the company. Under section 2(6A)(e) dividend includes:

“any payment by a company, not being a company, in which the public are substantially interested within the meaning of section 23A, of any sum (whether as representing a part of the assets of the company or otherwise) by way of advance or loan to a shareholder, or any payment by any such company on behalf or for the individual benefit of a shareholder to the extent to which the company in either case possesses accumulated profits.”

9. Sub-clauses (a) to (d) of section 2(6A) relate to the actual distribution by all companies including those which we can refer to for purposes of convenience as section 23A companies. The operation of sub-clause (e) is confined to section 23A companies, and sub-clause (e) deals not with any distribution by the company of its accumulated profits or other assets, but covers payments by way of advances or loans. Such a payment is deemed to be dividend, obviously dividend in the hands of the person who is in receipt of the payment. The reference to accumulated profits in sub-section (e) only places the upper limit on the amount brought to tax. For instance, if a company is possessed of accumulated profits to the extent of Rs. one lakh but makes payment to a shareholder of a sum of Rs. two lakhs, the operation of this deeming provision only treats Rs. one lakh in the hands of the shareholder as dividend. The important point to notice, however, is that the provision does not deem the payment to be still part of the accumulated profits of the company. It brings within its ambit any payment by a company which is not an actual distribution as a dividend but is camouflaged as a different transaction. It should, therefore, be clear that any sum paid to the shareholder cannot thereafter be regarded as accumulated profits of the company itself.

10. This necessarily leads to the conclusion that, even if the accumulated profits in the hands of the company were derived from agriculture and as agricultural income these profits were exempt from tax, the money received by the shareholder would not retain the same character. In other words, neither a dividend nor a deemed dividend paid out of agricultural income is itself agricultural income.

11. Even on general consideration it seems to us that the petitioner's argument, that there is identity of character of the amounts in the hands of the company and the shareholder, must fail. The learned counsel for the petitioner could not deny that, if the company in this case had actually distributed dividends, such dividends would be taxable in the hands of the petitioner, notwithstanding that the profits earned by the company out of which the distribution was effected were themselves not taxable. None the less, the learned counsel for the petitioner purported to draw some support for his argument from certain observations in Spencer v. Income-tax Officer, Madras. That case dealt with section 23A as it stood before its amendment in 1955. Under that provision it was open to the Income-tax Officer, if he found that the distribution of dividends by a company in which the public were not substantially interested was less than certain statutory percentages specified in the section, to deem the difference to have been distributed as dividends amongst the shareholders and to include the proportionate share of each shareholder in the total income of such shareholder for purposes of assessing his total income. In that decision the constitutional validity of section 23A was upheld. This court pointed out2:

“Undistributed profits of a company are still its profits. They constitute the income of the company. Until the company declares a dividend, ho portion of those profits can become the income of the shareholder. In England or in India the position is the same. The shareholder cannot compel the company by any process of law to declare a dividend. What section 23A did before it was amended in 1955 was to create a legal fiction.”

12. The further observations at page 119 were:

“What was it that was taxed: undisbursed profits. Undisbursed profits were undoubtedly income, a part thereof. True it was the income of the company and it remained as part of the assets of the company even after the taxing authorities had passed an order under section 23A. Except notionally, and then only for the purposes of the incidence of the tax, undisbursed profits did not become the income of the shareholders. None the less, the position remains that what was taxed, undisbursed profits, was income. The net profits of the company were subject to tax……… So, what section 23A did was, in essence, to tax income, the income of the company. Only, the incidence of that tax was not on the company in the first instance, but on the shareholder who had no doubt no legal right to get his share of the undisbursed profits of the company……….”

13. From these passages the learned counsel for the petitioner sought support for his contention that, notwithstanding the deeming provision and the recovery of tax from the shareholder, the income continued to be the income of the company, and that in the case of the petitioner the monies taken as loans from the company did not lose their character of agricultural income. That was not the point that was decided in that case. One of us was a party to that decision. The court was not called upon to decide in that case what was the nature of the money when it was deemed to have come into the hands of the shareholder. Apart from that, we have to point out that what we have to apply now are the provisions of section 23A as amended in 1955 and the provisions of section 2(6A)(e) which was simultaneously enacted. It was these amended provisions which were in force in the relevant assessment years. While under the old section 23A the incidence of the tax was on the shareholder, under the amended section 23A, the company itself is made liable to tax on the amount of its undistributed income. Contemporaneously with this amendment section 2(6A)(e) was introduced, enacting a fiction that any payment of the kind mentioned in the section by section 23A companies shall be deemed to be dividends in certain circumstances. There appears accordingly to be a clear distinction between the income in the hands of the company, which is now made directly taxable under section 23A, and a receipt by a shareholder of the kind specified in section 2(6A)(e). Even if the observations in Spencer v. Income-tax Officer, Madras, which we have extracted above, went to the extent of laying down that notwithstanding that the tax was recoverable from the shareholder on the undistributed profits of the company deemed to have been distributed they continued nevertheless to be the income of the company for all purposes, that should be referable to the state of the law as it was then, that is, before section 23A was amended in 1955.

14. We are, therefore, unable to accept the contention of the learned counsel for the petitioner that the monies he obtained as loans from Palkulam Estates (Private) Ltd., which fell within the scope of section 2(6A)(e) continued to retain that character as agricultural income.

15. Several other contentions were raised by the petitioner in the affidavit in these petitions, which really dealt with the correctness of the orders of assessment. We declined to consider these objections, as they could properly constitute points for decision in the statutory proceedings open to the petitioner under the Income-tax Act itself. We should not be considered to have expressed any opinion on the soundness or otherwise of these objections. We confined ourselves to only two questions, (1) the constitutional validity of section 2(6A)(e) and (2) whether what the petitioner obtained as loan from Palkulam Estates (Private) Ltd. constituted agricultural income. On both these points the petitioner failed and that is sufficient to direct the discharge of the rule nisi and the dismissal of the petitions. The petitioner will pay the costs in W.P No. 372 of 1959. There Will be no order as to costs in W.P No. 373 of 1959. Counsel's fee Rs. 250.

16. Petition dismissed.