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AMICUS AI
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Ramaprasada Rao
  • Ramanujam, JJ.
Acts
  • section 23A of the Indian Income-tax Act, 1922,
  • section 23A(1) of the Income-tax Act
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Cites
Cited by
Citation Codes
Equivalent Citations
citation codes
Case Number
Judges
  • Ramaprasada Rao
  • Ramanujam, JJ.
Acts
  • section 23A of the Indian Income-tax Act, 1922,
  • section 23A(1) of the Income-tax Act
See more information ...
Smart Summary

Structured Summary of the Opinion delivered by Ramaprasada Rao, J.

Factual and Procedural Background

The assessee is a private limited company engaged in manufacturing and selling bricks. For the assessment year 1961–62 the company declared a dividend of Rs. 12,000 at a general body meeting held on May 4, 1961. The Income-tax Officer, exercising jurisdiction under section 23A of the Income-tax Act, examined the return and concluded that the dividend was not properly declared and was not in accordance with law. The ITO therefore called upon the assessee to show cause why additional super-tax under section 23A should not be levied, and ultimately levied the additional super-tax.

The assessee appealed unsuccessfully to the Appellate Assistant Commissioner and then on second appeal to the Appellate Tribunal, which held that the company failed in its statutory duty with respect to declaration of dividends. The Tribunal observed that there were no prior losses, the profit in the previous year was Rs. 48,203, and that the creation of reserves were appropriations with no relevance to whether section 23A applied. The assessee applied to have a question of law referred; the question referred to this Court was whether the levy of additional super-tax under section 23A(1) for assessment year 1961–62 was valid.

Legal Issues Presented

  1. Whether, on the facts and in the circumstances of the case, the levy of additional super-tax under section 23A(1) of the Income-tax Act for the assessment year 1961–62 was valid?

Arguments of the Parties

Appellant's (Assessee's) Arguments

  • The Tribunal wrongly limited the Income-tax Officer’s jurisdiction to only those cases involving earlier losses or an arithmetically small profit; that limitation is unsustainable in light of this Court's and the Supreme Court's interpretations of section 23A.
  • The dividend was declared at a general body meeting; declaration of dividends is essentially a matter of the company's domestic management and within the province of the board of directors and the shareholders.
  • The company acted within its powers in declaring the dividend, and unless it can be clearly shown that the company exceeded its obligations or acted unreasonably, the ITO's jurisdiction under section 23A cannot be invoked.
  • The company was in a nascent stage (second year of operation) and had made reserves for strengthening resources and future preservation; appropriation to reserves was commercially justified and relevant to the reasonableness of the dividend.

Respondent's (Revenue / Income-tax Officer / Tribunal) Position

  • The Income-tax Officer found the dividend was not properly declared and called on the assessee to show cause; the revenue rejected the assessee's explanations and levied additional super-tax under section 23A.
  • The Tribunal concluded that the company failed in its statutory duty regarding declaration of dividends and stated that, in this case, there were no prior losses and the profit (Rs. 48,203) could not be regarded so small that declaring a higher dividend would be unreasonable.
  • The Tribunal additionally held that creation of reserves are appropriations and have no relevance to whether section 23A applies.

Table of Precedents Cited

Precedent Rule or Principle Cited For Application by the Court
Commissioner of Income-tax v. Gangadhar Banerjee and Co. [1965] 57 I.T.R 176 Explains that section 23A is in three parts: (1) scope of ITO jurisdiction; (2) manner of exercise of jurisdiction; and (3) assessment of statutory dividends in the hands of shareholders. The Court relied on this articulation to show the multipartite nature of section 23A and to emphasize that the ITO must follow the section's distinct requirements before acting.
Indian Commerce and Industries Co. Ltd. v. Commissioner of Income-tax [1966] 60 I.T.R 229 Reiterates that section 23A is penal in nature and that the burden is on the revenue to show conditions for making an order are satisfied; the ITO should consider matters from the board of directors' point of view and decide whether a further or larger dividend would be unreasonable in light of losses, smallness of profits and other relevant circumstances. The Court cited this authority to emphasize that the revenue must satisfy the statutory criteria, and that commercial/business considerations from the company's perspective (including withheld profits and appropriations) are relevant.
Commissioner Of Income-Tax, Madras v. Sundaram Industries Private Ltd. Notes the three limbs of section 23A and affirms that section 23A is susceptible to the test of reasonableness envisaged in the section. The Court used this precedent to support the proposition that the question of whether non-declaration of a statutory percentage of dividend is unreasonable must be judged by business considerations and is within the ambit of section 23A's reasonableness test.
Rayalaseema Passengers and Goods Transport v. Commissioner of Income-tax Holds that revenue should act strictly in accordance with the rules of guidance embedded in section 23A and be prompted by commercial expediency; where the Tribunal disagreed with reasoning, matter was remitted for reconsideration in light of observations. The Court referred to this case to show that the Tribunal's narrower interpretation was incorrect and that issues must be reconsidered with the statutory guidance and commercial considerations in mind; the present Tribunal's conclusion was found to run counter to these authorities.

Court's Reasoning and Analysis

The Court began by underlining the penal nature of section 23A and the consequent requirement that the revenue clearly establish the statutory ingredients and circumstances before invoking that section. The Court emphasized three interrelated points derived from precedent and statutory interpretation:

  1. Nature of Decision on Dividends: Declaration of dividends is primarily an internal matter of the company's management — dealt with by the board of directors and ultimately by the general body of shareholders — and thus forms part of the company's domestic or indoor management. As such, judicial or administrative scrutiny must apply tests of commercial reasonableness rather than purely arithmetical comparisons.
  2. Test of Reasonableness: The statute mandates that a larger dividend than that declared would be unreasonable before the ITO can act. The Court cited authorities establishing that the reasonableness question must be judged from the standpoint of a prudent businessman, considering business factors such as previous losses, present profits, availability of surplus money, and reasonable requirements for the future.
  3. Relevance of Appropriations and Reserves: The Court rejected the Tribunal's categorical statement that creation of reserves (appropriations) had no relevance to the investigation under section 23A. It held that in a nascent company — such as the assessee, in its second year of operation — it is commercially plausible and permissible to make reserves for future preservation and strengthening. The mere arithmetical largeness of profit does not alone establish unreasonableness if funds are diverted for legitimate commercial purposes.

Applying these principles to the case, the Court concluded that the Tribunal's approach was too narrow. The Tribunal had limited the scope of the ITO's inquiry to prior losses and the smallness of profit, and had disregarded appropriations to reserves. That approach was contrary to the ratio of the cited Supreme Court and this Court decisions which require a broader, business-focused assessment. Consequently, the Tribunal's findings could not be sustained without a reconsideration that applies the statutory guidance and business considerations laid down in the authorities.

Holding and Implications

Holding: The Court answered the referred question in favour of the assessee and remitted the matter to the Appellate Tribunal to re-hear the appeal and decide it in light of the observations made in this opinion.

Implications and direct consequences:

  • The Tribunal's order, insofar as it was based on a restricted view of the ITO's jurisdiction under section 23A (limited to prior losses and an arithmetically small profit and excluding appropriations to reserves), is set aside for reconsideration in light of the Court's guidance.
  • The Tribunal is required to re-hear the appeal applying the statutory three-part structure of section 23A and the business-reasonableness test as articulated by the precedents cited in this opinion.
  • There will be no order as to costs.
  • The Court did not purport to lay down a new grammatical or statutory rule beyond the application of established precedents; the order's effect is to require reconsideration consistent with existing authorities rather than to establish a novel precedent.

This summary is prepared strictly from the content of the provided opinion. No information beyond the opinion's text has been added or inferred.

Show full summary ...

    Alavai Industries Private Ltd. v. Commissioner Of Income-Tax, Madras

    The Judgment of the Court was delivered by

    Ramaprasada Rao, J.:— The assessee is a private limited company carrying on business in the manufacture and sale of bricks. For the assessment year 1961–62, the assessee declared a dividend of Rs. 12,000 at the general body meeting held for the purpose on May 4, 1961. The Income-tax Officer, in exercise of his jurisdiction under section 23A, while scrutinising the return of the assessee, found that the dividend was not properly declared and that such a declaration was not in accordance with law, and he therefore called upon the assessee to show cause why additional super-tax under section 23A should not be levied. It is not necessary for us to scrutinise the quantum of the profits as alleged by the assessee and as noticed by the Income-tax Officer, in view of the ultimate opinion which we are going to render in the instant case. The assessee explained that the distribution of the dividend was reasonable and was a matter which was considered by the general body of the company in question, and, in any event, such a dividend was declared by the company after it made certain reserves for the benefit and for the strengthening of the resources of the company. The revenue rejected the submissions made by the assessee and levied the additional super-tax as prescribed. The appeal by the company to the Appellate Assistant Commissioner was not successful. Even before the Appellate Tribunal, on second appeal, the company failed. Before the Tribunal, the company expressly took up the position that the business of the company was in a nascent stage as the year of assessment was its second year of operation and that any further declaration of dividend as demanded by the revenue would be to disturb the capital structure of the company and its prospects. Other questions regarding the sufficiency of the notice contemplated in section 23A(2) were raised, but they are not pressed before us. The Tribunal, after hearing the counsel, came to the conclusion that the company failed in its statutory duty in the matter of declaration of the dividends. It observed as follows:

    “The Income-tax Officer has only to consider the past losses and whether the profit made in the previous year was so small that the payment of higher dividend would be unreasonable. In this case there are no prior losses. The profit made by the assessee-company in the previous year is Rs. 48,203. The profit has to be understood in the commercial sense and we cannot say that it is so small that a declaration of higher dividend would be unreasonable. As rightly pointed out by the Appellate Assistant Commissioner, the creation of reserves are appropriation and have no relevance in finding out whether the provisions of section 23A apply or not.”

    2. On an application by the assessee to refer a question of law arising out of its order, the following question has been referred to us to render our answer thereon:

    “Whether, on the facts and in the circumstances of the case, the levy of additional super-tax under section 23A(1) of the Income-tax Act for the assessment year 1961–62 was valid ?”

    3. Mr. Srinivasan, learned counsel for the assessee, while repeating the contentions earlier made by him before the revenue and the Tribunal, contends that the order of the Tribunal in that they limited the exercise of jurisdiction by the Income-ax Officer only in cases where the profit is arithmetically small and if the assessee incurred past losses and that such limitation imposed by the Tribunal, as is seen from the excerpt above, are unsustainable in view of the interpretation of the said section by this court and the Supreme Court. He would also urge that in the instant case dividends were declared at the general body meeting held by the company for the purpose, amongst others, and the declaration of dividend being essentially a matter which is domestic, the company acted exclusively within its province and unless it could be clearly said that it has exceeded its obligations and has declared a dividend one way or the other unreasonably, then only the jurisdiction of the Income-tax Officer, if at all, can be invoked under section 23A. In our view, this contention is well founded. It is by now well settled that section 23A of the Indian Income-tax Act, 1922, being penal in nature the jurisdiction which the revenue could exercise under that section is exercisable only and only if the ingredients and the circumstances set out in the section are clearly brought out and established. Inter alia, one of the mandates provided for in the section is that a larger dividend than that declared would be unreasonable. The declaration of a dividend by a company is essentially a matter to be dealt with by the board of directors and ultimately by the general body. It is one amongst many events which are inter-related or laced with domestic or indoor management of a company. It may be expected that when a company declares a dividend at a meeting of its general body, then the body of shareholders are conscious and aware as to what funds are available for such dividends and what percentage out of it should be made available to the shareholders and what portion of such profits should be reserved for future enterprises, expansion and benefits of the company. This, as we stated earlier, is a matter pertaining to the internal management of the company, and therefore it is that “the arm-chair principle” has been invoked to find whether the decision or act of the company is unreasonable from the commercial point of view and whether such a decision would not satisfy the acid test of reasonableness.

    4. Yet again, there is another limb in section 23A which, in the context, throws some light upon the jurisdiction of the revenue to act under it. It is the smallness of the profits made in the previous year. What is small to the revenue may not be so small to the company and vice versa. Whether it is small at all, is once again to be decided by the company itself, having regard to its various trading activities in the past, present and future. In the instant case, this is a nascent company working in the second year of its operation. It could easily be conceived that such a company should make some reserves for its future preservation and for its future good. If such profits, therefore, are diverted for that purpose, it is essentially for commercial reasons. Then, notwithstanding the fact that a portion of such profits—viewed by the revenue as large—has been diverted for such projects connected with the company in future, that it cannot be said by the mere arithmetical largeness of the total profit, that the dividend declared was not proper. It is not necessary for us to fully delve deep into the scope and meaning of section 23A in view of the decided cases. In Commissioner of Income-tax v. Gangadhar Banerjee and Co. [1965] 57 I.T.R 176, Subba Rao J., as he then was, speaking for the Bench, said at page 181 as follows:

    “The section is in three parts: the first part defines the scope of the jurisdiction of the Income-tax Officer to act under section 23A of the Act; the second part provides for the exercise of the jurisdiction in the manner prescribed thereunder and the third part provides for the assessment of the statutory dividends in the hands of the shareholders.”

    5. If, in a given case, the Income-tax Officer makes an order declaring that the undistributed portion of the assessable income less taxes to be paid shall be deemed to have been distributed as dividends among the shareholders, a duty is equally cast on him to find out whether there were earlier losses or the profit is small. In that connection, said the Supreme Court:

    “What does the expression ‘profit’ mean? Does it mean only the assessable income or does it mean commercial or accounting profits?….

    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.”

    6. In Indian Commerce and Industries Co. Ltd. v. Commissioner of Income-tax [1966] 60 I.T.R 229, 233., this court, after reviewing the decision, reiterated that section 23A is of a penal nature and the burden is on the revenue to show that the conditions for making an order are satisfied. Veeraswami J., as he then was, observed:

    “In determining the effect of withheld profits, the Income-tax Officer should consider matters from the point of view of the board of directors. He must arrive at a finding that a further or larger dividend than that declared would not be unreasonable, with reference not only to the losses incurred by the company in earlier years and the smallness of the profits made during the relevant year but also to all other relevant circumstances.”

    7. In the end the learned judge said: “The approach to the question should be on business considerations in the light of particular facts.”

    8. To a similar effect is the decision of this court in Commissioner Of Income-Tax, Madras v. Sundaram Industries Private Ltd. noting the three limbs of section 23A, the court observed that one such part of section 23A concerns itself with the jurisdiction and the second with the exercise of such jurisdiction. Regarding the third part, namely, the propriety of the quantum of dividend, the court said:

    “Notwithstanding the statutory prescription by reason of the amendments noted (in that case 100 per cent. was the prescription)… the Income-tax Officer should find that the act of the company in not having declared the statutory percentage of dividend is unreasonable. We are of the view that section 23A of the Indian Income-tax Act, 1922, is susceptible to the test of reasonableness envisaged in the section.”

    9. Again, in Rayalaseema Passengers and Goods Transport v. Commissioner of Income-tax, where a similar question arose, this court, while disagreeing with the reasoning of the Tribunal, had to remit the appeal to the Tribunal for a reconsideration in the light of the observations made therein. In this case also it was made clear that for determining the available profits for purposes of section 23A, the revenue should act strictly in accordance with the rules of guidance embedded in the section itself and should also be prompted to exercise their jurisdiction in the context of commercial expediency as well. Viewed in the light of the dicta as noticed above, the Tribunal went wrong in observing that the Income-tax Officer is only to consider the past losses and whether the profit made in the previous year was so small that the payment of a higher dividend would be unreasonable. Their understanding of the section that the creation of reserves or of appropriation for the same have no relevance to the investigation under section 23A is obviously running contra to the ratio of the decision of the Supreme Court and our court referred to above.

    10. In these circumstances, while answering the question in favour of the assessee, we remit the matter to the Tribunal to re-hear the appeal and decide the same in the light of the observations made herein. There will be no order as to costs.

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    Comments

    Alavai Industries Private Ltd. v. Commissioner Of Income-Tax, Madras
    (Nov 4, 1969)