SECOND INCOME TAX OFFICER v. BHAGAVATHY INVESTMENTS (P) LTD
[Citation -1985-LL-1205-10]

Citation 1985-LL-1205-10
Appellant Name SECOND INCOME TAX OFFICER
Respondent Name BHAGAVATHY INVESTMENTS (P) LTD.
Court ITAT-Chennai
Relevant Act Income-tax
Date of Order 05/12/1985
Assessment Year 1980-81
Judgment View Judgment
Keyword Tags declaration of dividend • distributable income • financial condition • method of valuation • capital expenditure • capital investment • written down value • valuation of stock • investment company • additional income • assessable income • commercial profit • notional income • notional profit • general reserve • additional tax • closing stock • new machinery • opening stock • equity share • cash balance
Bot Summary: In fact the profits of the company arise mainly out of sale of such shears. The difference of over Rs. 2.07lakhs does not represent profits actually realised. The profit as per the PL A/c was Rs. 2,76,570. Then on account of the valuation of the stocks of securities there was only a notional profit of Rs. 2,07 lakhs, Taking all these factors into consideration, the distribution of the dividend of Rs. 93,660 is quite reasonable. The Bombay High Court in Indian Express News Papers Pvt. Ltd. vs. CIT, Bombay City-I 12 CTR 258: 120 ITR 249 on the facts of the case held that the company was virtually in the first year of its proper functioning and there is bound to be an expansion programme and while determining as to what amount out of the commercial profits should be distributed by way of dividend any prudent businessman or directors of a company are bound to have an eye on future financial requirements. In Alavai Industries Private Ltd. vs. CIT, Madras 76 ITR 310 the Madras High Court held that it could be easily conceived that a company should make some resaves for its future preservation and if such profits are diverted for that purpose, it is essentially for commercial reasons. If a portion of such profits have been diverted for such projects connected with the company in future, it cannot be said by the mere arithmetical largeness of the total profit, that the dividend declared was not proper.


T.VENKATAPPA, J. M.: This appal relates to levy of additional income tax under s. 104 of IT Act. ITO found distributable income was Rs. 1,73,458 and dividend distributed was Rs. 93,660. assessee is investment company and therefore, should have distributed 90 per cent i.e. Rs. 1,56, 112. Thus, there was short distribution to extent of Rs. 62,452 After obtaining approval of IAC he levied additional tax of Rs. 39,899 under s. 104. assessee appealed to CIT (A). Before him it was urged that assessee purchased shares to extent of Rs. 1,28,000. Out of profit which were held as stock in trade. Further, cash balance available was not sufficient to declare statutory percentage of dividend. CIT (A) held that investment in new shares is one such commercial obligation imposed on company by virtue of its character as investment company. In fact profits of company arise mainly out of sale of such shears., In view of this fact company would not have been in position to declare larger dividend than was made available by company to its shareholders. Thus, levy of additional tax is not justifies. He also found that though P & L a/c disclosed net profit of Rs. 2,76,570 there is certain artificiality about same, inasmuch as it results from certain mode of valuation of stock. opening stock is valued at Rs. 11.35 lakhs and closing stock of securities at Rs. 13,42 lakhs. difference of over Rs. 2.07lakhs does not represent profits actually realised. It represents only sort of notional profits credited to accounts employing mode of accounting for purpose of income tax assessment. Thus, he cancelled order under s. 104 against same. Revenue is in appeal. ld. Departmental Representative kly urged that capital expenditure in purchase of shares need not be out of profits of this year. Hence, that cannot be taken into consideration in judging shortfall in dividend declared, as there is no commercial obligation to invest in purchase of new shares. Since assessee has failed to declare statutory percentage of dividend s. 104 applies. He placed reliance on decision of Gauhati High Court in CIT, Assam, Nagaland, Manipur and Tripura vs. Ahmed Tea Co. Pvt. Ltd. (1977) 108 ITR 853 (Guj). ld. counsel for assessee submitted that assessee being dealer in shares was obliged to invest in purchase of new shares. On account of purchase of new shares and taking into account cash availability, higher dividend could not be declared. He also submitted that on account of valuation of stock there was only notional profit credited to accounts for purpose of income tax assessment and no cash was available. He supported order of CIT (A). We have considered reveal submissions. assessee is investment company. It purchases and sells shares. profit as per P&L A/c was Rs. 2,76,570. During this year assessee had sold shares to extent of Rs. 1,27,341 and had purchased new shares of Rs. 2,55,343. For purchase of new shares assessee utilised profits of this year to extent of Rs. 1,28,000. assessee transferred Rs. 27,000 to general reserve. It made provision of Rs. 98,000 for taxation. assessee declared dividend of Rs. 93,660. By method of valuation adopted by assessee in respect of stock of securities there was notional profit of 2.07 lakhs which formed part of net profit of Rs. 2,76,570 in P&L a/c. In Directors report dt 21st Aug. 1980 it was stated that in view of continuing tight cash position they were not able to declare dividend larger than 25 per cent on equity share capital. On above facts, question for consideration is whether s. 104 could be applied. In our view s. 104 cannot be applied. business of assessee is purchase and sale of shares. Directors thought fit that it would be prudent to invest sum of Rs. 1,28,000 out of profits of this year in purchase of new shares. This action of Directors has to be judged from business point of view. If it is considered form that angle, purchase of new shares out of profits of this year was essential for purpose of business of company. Hence that has to be exclude out of available profits. Then transfer of Rs. 27,000 to general reserve was necessary in view of provisions of s. 205 of Companies Act. Then on account of valuation of stocks of securities there was only notional profit of Rs. 2,07 lakhs, Taking all these factors into consideration, distribution of dividend of Rs. 93,660 is quite reasonable. assessee did not have any further availability of cash for declaring more dividend. That is relevant factor to be taken into consideration. Thus, in our view s. 104 has no application. It will be useful to refer decided case law. In CIT Weest Bengla vs. Gangadhar Banerjee and Co. (P) Ltd. (1965) 57 ITR 176 (SC) at 181 Supreme Court observed as under: "The ITO acting under this section, is not assessing any income to tax that will be assessed in hands of shareholder. He only does what directors should have done. He puts himself in place of directors. Though object of section is to prevent evasion of that, provision must be worked not from standpoint of tax collector but from that of businessman. yardstick is that of prudent businessman. reasonableness or unreasonableness of amount distributed as dividends is judged by business considerations, such as previous losses, present profits, availability of surplus money and reasonable requirements of future and similar others. He must take overall picture of financial position of business. It is neither possible nor advisable to lay down any decisive tests for guidance of ITO. It depends upon facts of each case. o n l y guidance is his capacity to put himself in position of prudent businessman or director of company and his sympathetic objective approach to difficult problem that arise in each case. We find it difficult to accept argument that ITO cannot take into consideration any circumstances other than losses and smallness of profits, This argument ignores expression "having regard to" that precedes said words." Thus, it was observed therein that reasonableness or unreasonableness of amount distributed and dividend is judged by business considerations such as previous losses, present profits, availability of surplus money and reasonable requirements of future and similar others. In CIT, West Bengal vs. Bangodaya Cotton Mills Ltd. (1968) 69 ITR 812 (Cal) Calcutta High Court held that company in matter of distribution of dividends has necessarily to deduct not only admissible and revenue expenses but also other commitments and outgoing, even though they may be of capital and in admissible nature, to find out amount, which has been actually left with it to be distributed as dividend. It would not be proper to consider only past losses and present profits and to ignore availability of surplus money and reasonable requirements of future. In Indo-Ceylon Dental and Surgical Co. Ltd. vs. CIT, Madras (1975) 98 ITR 536 (Mad) Madras High Court held that unless there is positive material to show that board of directors or general body resolved to declare as lesser dividend with view to build up sufficient reserves to be utilised for such developmental activity it is not possible to assume that declaration of lesser dividend was for reason that Board of Directors or General body required finance for developmental activity. Bombay High Court in Indian Express News Papers (Bombay) Pvt. Ltd. vs. CIT, Bombay City-I (1979) 12 CTR (Bom) 258: (1979) 120 ITR 249 (Bom) on facts of case held that company was virtually in first year of its proper functioning and there is bound to be expansion programme and while determining as to what amount out of commercial profits should be distributed by way of dividend any prudent businessman or directors of company are bound to have eye on future financial requirements. In CIT vs. Bombay City-I vs. Gagalbahi Jute Mills P. Ltd. (supra) assessee had big rehabilitation programme and had acquire new machinery out of borrowings. Tribunal accepted assessee s contention that requirements of rehabilitation should be considered before applying s. 23A (1) of IT Act, 1922. On reference. Bombay High Court held that Tribunal could not have come to any other conclusion. it could be said that from businessman s standpoint it was necessary to conserve profits earned by company and not distribute larger amount by way of dividends. In Alavai Industries Private Ltd. vs. CIT, Madras (1970) 76 ITR 310 (Mad) Madras High Court held that it could be easily conceived that company should make some resaves for its future preservation and if such profits, therefore, are diverted for that purpose, it is essentially for commercial reasons. If portion of such profits have been diverted for such projects connected with company in future, it cannot be said by mere arithmetical largeness of total profit, that dividend declared was not proper. It was further held that declaration of dividend by company is essentially matter to be dealt with by board of directors and ultimately general body. In CIT vs. Binani Investment Co. (P) Ltd. (1982) 27 CTR (Cal) 170: (1982) 138 ITR 845 (Cal), Calcutta High Court held that if company though it proper to liquidate its debt out of its distributable income or available surplus, then it could not be said to have acted imprudently or unreasonably. It was further held that it could not be said that company acted in any unreasonable manner in transferring certain sum to general reserve account. In CIT, Bombay City vs. Bipinchandra Maganlal & Co. Ltd. (1961) 41 ITR 290 (SC) Supreme Court held that difference between written down value of asset and price realised by sale thereof, is not really income, but is made taxable income, for purpose of computation of assessable income, by fiction in second proviso to s. 10(2) (vii) of IT Act, read with s. 2(6C). On that account it does not become commercial profit and is not liable to be taken into account in assessing whether in view of smallness of profits larger dividend would be unreasonable. In J. P. Srivastava and Sons (Bhopal) Pvt. Ltd. vs. CIT Madhya Pradesh (1965) 57 ITR 624 (SC) Supreme Court held that under managing agency agreement assessee-company did not have any right to receive commission till general meeting of managed company was held and therefore it could not form part of accounting profits even though it is included in assessee s income in income-tax assessment on basis of accrual. principle that emerge out of above decisions are that reasonableness or unreasonableness of amount distributed as dividend is to be judged by business considerations, such as previous losses, present profits, availability of surplus money and reasonable requirement of future and similar other and overall picture of financial position of business should be taken into account. Even capital investment for discharge of any liability has to be excluded from profit of company. amounts transferred to general reserve have to be excluded at arrive at available profits for distribution. notional income does not become commercial profit. cash availability is factor to be taken into consideration. Applying ratio laid down in above cases, we are of view that s. 104 cannot be applied to instant case. dividend distributed amounting to Rs. 93,660 was reasonable, Thus, CIT (A) was justified in cancelling order made under s. 104 of IT Act. decision of Gauhati High Court in CIT vs. Ahmed Tea Co., Pvt. Ltd. (1977) 108 ITR 853 (Gau) is distinguishable. That is case where it was found that company was in as sound financial condition and was capable of declaring dividend at statutorily prescribed rate. Hence, it has no application. We do not think that s. 107-A would in any way help Revenue. Thus, we uphold order of CIT (A). In result, appeal fails and is dismissed. *** SECOND INCOME TAX OFFICER v. BHAGAVATHY INVESTMENTS (P) LTD.
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