DELHI FARMING AND CONSTRUCTION (P) LTD. v. COMMISSIONER OF INCOME TAX, DELHI

Citation: [2003] 3 S.C.R. 35

Court: Supreme Court of India

Bench: RUMA PAL, B.N. SRIKRISHNA

Judgment text

DELHI FARMING AND CONSTRUCTION (P) LTD. v. COMMISSIONER OF INCOME TAX, DELHI MARCH 26, 2003 [RUMA PAL AND B. N. SRIKRISHNA, JJ. ] Income Tax Act, 1961: Sections 2(24)(vi) and (45), 45, 47(viii), 104 and 109(1)-levy ofSuper Tax on undistributed income ofinvestment company-Capital gain to assesseecompany prior to 1. 3.

1970 by compulsory acquisition of agricultural land- Decision by Directors of the assessee-company not to use the money for payment of dividend due to past losses and meagreness of the profit for the current years-income tax officer holding the company liable to additional income tax-Propriety oflevy-Held : The Capital gain could not have been subjected to tax as it was wholly exempted from 'capital gains' and was not part ofthe 'gross income' or 'distrib11table income' for the purpose ofSection 104-Whether capital gains are commercial or business profits on which dividends could be distributed would depend on the facts and circumstances ofeach case based upon commercial decision of Directors ofthe company- Deci:;ion of the Directors was not unreasonable and hence the income tax officer was not justified in sitting in appeal over the business decision ofthe Directors of the Company.

Section 104-Jurisdiction ofincome tax officer-Scope of-Held, income lax officer can only consider whether the Board ofDirectors acted reasonably- Cannot arrive at conclusion that payment ofdividend or larger dividend than that declared would be unreasonable in view of losses incurred or due to smallness ofthe profits in the current years since it is business consideration. Appellant-assessee, an investment company got compensation prior to 1. 3. 1970, by reason of compulsory acquisition of agricultural land. The Directors of the company decided not to fritter away the money of compensation by payment of dividend due to past losses and the smallness of the profit for the current year and they transferred the amount to capital reserve. Assessee was subjected to levy of income tax under Section 104 of Income Tax Act, 1961 for the assessment years 1974-75, 1975-76 [2003) 3 S. C. R.

and 1976-77 for its failure to distribute the required statutory percentage of dividend during the concerned previous years ending on 31. 3. 1973, 31. 3. 1974 and 31. 3. 1975 respectively. Income Tax Officer held that there was sufficient money in the hands of the appellant which could and ought to have been declared as dividend and thus held the Company liable to additional income tax for the years 1974-75 and 1975-76. The order was upeheld by Appellate Commissioner in appeal. In further appeal Income Tax Appellate Tribunal held that provisions of Section 104 of the Act could not be invoked in both the assessmen1: years and gave full relief to the appellant-Company. On reference with respect to the three assessment years, High Court decided in favour of Revenue.

In appeal to this Court appellant contended that the sale proceeds of agricultural land are totally exempt from the charge of tax under Section 45 of the Act by reason of Section 47(viii), hence, the capital gains accruing as a result of the compensation paid could never have formed part of the "total income" of the appellant-assessee; that capital gains are not commercial or business profits, nor are they income in the true sense of the term, although by legislative fiction they have been included within the scope of 'income' and made subject to tax; and that the income-tax officer cannot sit in appeal over the business decision taken by the Board of Directors of the appellant company.

Allowing the appeals, the Court HELD: I The entire amount of capital gains which accrued as a result of acquisition (and hence compulsory transfer) of the agricultural land could not have been subjected to tax under Section 104 of the Income Tax Act, 1961 as it was wholly exempted from capital gains and not part of the 'gross income' or the 'distributable income' for the purpose of Section 104 of the Act. Even assuming that compulsory acquisition of land is transfer of a capital asset within the meaning of Section 45 of the Act, Section 47(viii) specifically exempts any transfer of agricultural land in India effected before the ! st day of March, 1970 from the scope of Section 45 of the Act. Thus, the compensat1ion which became payable to the appellant as a result of the acquisition of its agricultural land in 1962, was totally exempt from Section 45.

Consequently, it did not amount to 'income' within the meaning of Section 2(24)(vi) as there was no 'capital gain' within the meaning of Section 45.. It was also not to be included while computing the total income of the appellant as defined in Section 2(45) of DELI-II FARMING AND CONSTRUCTION IP) LTD. v. Cl. T the Act. Thus, the amount of compensation received by the appellant could not have formed part of the "gross total income" within the meaning of clause (iv) of Section I09 of the Act. Consequently, there was no question of its becoming part of "distributable Income" as defined in Section 109(1). [43-B, E[ Cardamom Marketting company (TRA V), ltd v. Commissioner of Income Tax, (1986) 158 ITR 621 and Commissioner ofIncome Tax v. South India CorporaOon ltd, (1990) 183 ITR 361 (Ker. ), referred to. 2. There cannot be a hard and fast rule that capital gains ought or ought not to be treated as commercial or business profits on which dividends could be distributed.

It would ultimately depend on the facts and circumstances of each case based upon which the Board of Directors take a commercial decision as to whether dividend should be distributed thereupon or not. [45-E[ C/Tv. Gannon Dunkerley and Co. ltd, (1971) 79 ITR 637; C/Tv. N. Guin and Co. (P) ltd, I (1979) ll6 ITR 475 and Factors (P) ltd v. Commissioner ofIncome Tax, Madras, (1975) 98 ITR 105, referred to. 3. I. The jurisdiction of the Income-tax Officer under Section 104 of the Act is hedged in by two prerequisite satisfactions on his part. First, that profits and gains are distributed at less than the statutory percentage . of distributable income; second, that having regard to the losses incurred by the company in earlier years, or due to the smallness of the profits made in the previous year, the payment of dividend or a larger dividend than that declared would be unreasonable. The second satisfaction brings in business considerations.

[45-G, H; 46-A[ Commissioner ofIncome-Tax (Central) Calcutta v. Asiatic Textiles ltd, (1971) 82 ITR 816; CIT v. Bipinchandra Magan/al & Co. , (1961) 41 ITR 290 and CIT v. Gangadhar Bane1jee and Co.. (1965) 57 ITR 176, referred to. 3. 2. The words "having regard to" used in the Section 104 of the Act do not restrict the consideration only to two matters indicated in the Section as it is impossible to arrive at a conclusion as to reasonableness by considering only the two matters mentioned isolated from other relevant factors. It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income-tax Officer. The satisfaction [2003) 3 S. C. R. depends upon the facts of each case. The only guidance is his capacity to put himself in the position of a prudent businessman or the director of a company and his sympathetic and objective approach to the difficult problem that arises in each case. 146-G, H; 47-AI 3. 3.

Taken against the background of the accumulated losses of the company over several financial years, together with the loss of the only asset of the company, there was nothing unreasonable in the decision of the Board of Directors not to distribute dividends from the compensation awarded but to capitalize it in a reserve account. The second statutorily required satisfaction could not have been arrived at by the Income-tax Officer so as to exercise jurisdiction under Section I 04 of the Act. 147-B, Cl CIVIL APPELLATE JURISDICTION : Civil Appeal Nos. 7525-7527 of 2001. From the Judgment and Order dated 25. 5. 200 I of the Delhi High Court in l. T. R. Nos. 301and302of1981. Ranjit Kumar and Ms. Anu Mohla,, for the Appellant. T. L. V. Iyer, P. S. Narasimha and P. Sridhar. for the Respondent. The Judgment of the Court was delivered by SRIKRISHNA, J.

The assessee is a company registered under the provisions of the Companies Act and c:arrying on business in agricultural activities and dairy farming. The assessee was subjected to levy of incometax under section I04 of the Income Tax Act, 1961 ('the Act') for the assessment years 1974-75, 1975-76 and 1976-77. for its failure to distribute the required statutory percentage of dividend during the concerned previous years ending on 31st March 1973. 31st March 1974 and 31st March 1975, respectively. The figures of total income-tax assessed and the distributable surplus as computed by the Income-tax Officer for the assessment years 1974-75 and 1975-76, are as under: Assessment year 1974-75 1975-76 H1 Total income assessed Rs. 3,22,580 Rs. 72. 130 ( "' DELHI FARMING AND. CONSTRUCTION (P) LTD. v. C. I. T. (SRIKRISHNA, J. ] 39 2 Less taxes payable thereon Rs. 2,20,160 Rs. 49,228 3 Distributable surplus Rs. 1,02,420 Rs. 22,902 4 Dividends that ought to Rs. 92,223 Rs.

20,612 have been declared by the company, i. e. 90% 5 Dividend declared by Nil Nil the assessee company 6 Debit balance in profit Rs. 91,472 Rs. 20,508 ~ t and loss account 7 Capital reserve shown in Rs. 7,45,109 Rs. 7,45,109 the balance-sheet The petitioner's business of agricultural activities had resulted in losses year after year and the accumulated losses at the commencement of the year 1974-75 was Rs. 3,93,610 and for the year 1975-76 the loss was Rs. 91,472. During the year 1962 certain agricultural land belonging to the appellant company was compulsorily acquired. There was a long drawn litigation with regard to the compensation payable to the appellant. The appellant was awarded a sum of Rs. 7,64,787 as compensation towards the acquired land on which an amount of Rs. 2,94,844 became payable as interest. This amount of interest ·' was paid on different dates during February 1973.

Since the compensation was payable immediately upon acquisition of the land, the appellant-assessee took the view· that the interest earned on the compensation had to be apportioned over the years 1962 to 1972. A sum of Rs. 20,357. 91 only was credited as interest for the period ending 3 1st March, 1973 and the balance was credited towards the earlier periods. The compensation amount of Rs. 7,45,109. 72, being capital gain on the land compulsorily acquired by the __,__ Govemment, was transferred to capital reserve and shown as such in the balance sheet. The Directors of the appellant company took the view that there was no possibility of distributing dividend in the concerned three accounting years on account of the past losses including the loss of the only asset of the company i. e. agricultural land. It was, therefore, thought prudent to capitalize the compensation amount in a capital reserve account and not fritter it away ... _ by distribution of dividend.

For the financial year ending 30. 6. 1973 the Income-tax Officer assessed the income as Rs. 3,22. 580 and for the financial year ending 30th June, 1974 the total income was assessed at Rs. 72,130. Since the appellant had not declared ariy dividend during the aforesaid accounting years, the Income-tax Officer issued notices to the appellant under sect:on I04 of the Act for the assessment years 1974-75 and 1975-76. The appellant contended that, because of the past accumulated losses and the smallness of the profit for the current year payment of any dividend would have been unreasonable, and, therefore, it had decided not to fritter away the money available in its hand as compensation. The Income-tax Officer, however, disagreed and took the view that there was sufficient money in the hands of the appellant which could and ought to have been declared as dividend.

He was also of view that the appellant was an investment company and there was substantial capital available as reflected in the capital reserve of Rs. 7,45,109. He also held that such a huge capital reserve was not required by the company for the purpose of any business requirement. Consequently, the Income-tax Officer held that the appellant was liable to additional income-tax of 50% of the profit available, which was fixed at Rs. 51,210 for the year 1974-75 and Rs. 11,451 for the year 1975-76. The appeals tiled by the appellant before the Appellate Commissioner of the Income Tax were rejected by upholding the orders of the Income-tax Officer. Further appeals to the Income Tax Appellate Tribunal resulted in full relief to the appellant as the Tribunal agreed with the contentions of the appellant and held that the provisions of section 104 of the Act could not be invoked by the Income-tax Officer in both the assessment years i. e. 1974-75 and 1975-76.

At the instanci: of Revenue a reference was made under section 256(1) of the Inc:ome Tax Act, 1961 to the High Court of the following questions of law : "I. Whether on the facts, and in the circumstances of the case, the Tribunal was right in law in holding that the capital gains of Rs 7,45,109 could not be considered for purposes of computing the distributable income of the assessee-company for the purposes of section 1N of the Income Tax Act, 1961, and (2) If the answer to the first question is in the negative, whether the Tribuna. i was right in canct:lling the orders passed by the Income- Tax Officer, u/s I04 of the Act for the two assessment years DELHI FARMING AND CONSTRUCTION (P) LTD. v. C. l. T. [SRIKRISHNA, J. ] 41 1974-75 and 1975-76 ? " -> By a common judgment dated 25. 5. 2001 the High Court answered both the questions against the assessee and in favour of the Revenue and also disposed of another reference pertaining to assessment year 1976-77, by taking the same view.

Hence, these three appeals. '- Section I04 of the Act at the material time read as under: "S. I04. Super-tax on undistributed income of certain companies:- (I) Subject to the provisions of sub-section (2) and of Sections 105, ~ 106 and 107, where the Income-tax Officer is satisfied that in respect of any previous year the profits and gains distributed as dividends by any company within the twelve months immediately following the expiry of that previous year are less than the -- a hard and fast rule that capital gains ought or ought not to be treated as commercial or business profits on which dividends could be distributed. It would ultimately depend on the facts and circumstances of each case based upon which the Board of Directors take a commercial decision as to whether dividend should be distributed thereupon or not. In any event, it appears to us that nothing turns on the second contention as far as the present appeals are concerned.

' The third contention urged by the appellant-assessee is equally t formidable. The High Court in the impugned judgment seems to have assumed that the moment the Income-tax Officer is satisfied in respect of any previous ""'"' year that the profits and gains distributed as dividends by any company within 12 months immediately following the expiry of that previous year are less than the statutory percentage of the distributable income of the company of that previous year, an order in terms of section 104 must necessarily be passed. In our view, the jurisdiction of the Income-tax Officer under Section I04 is hedged in by two prerequisite satisfaction on his part. First, that profits and gains are distributed at less than the statutory percentage of distributable income; second, that having regard to the losses incurred by the company in earlier.

years, or due to the smallness of the profits made in the previous year, ~ the payment of dividenc;l or a larger dividend than that declared would be ' unreasonable. The second satisfaction, in our view, brings in business I ! ....... considerations. As this Court observed in Com1111:~sioner of Income-Tax (Central), Ca/cul/av. Asiatic Textiles Ltd. (1971) 82 ITR 816. while discussing case under section 23A of the 1922 Act, it is not open for the Income-tax Officer to constitute himself as a 'super-director' in this regard. In CIT v. Bipinchandra Magan/al & Co. , (1961) 41 ! TR 290 this Court pointed out that the legislature has deliberately used the expression "smallness of profits" and not "smallness of the assessable income" and there is nothing in the context which would require equation of the expression "profit" with "assessable income".

Smallness of the profit in section 23A has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional. It was also pointed out that a company normally distributes dividends out of its business profits and not out its assessable income. There is no definable relation between the assessable income and the profits of a busintss concern in a commercial sense. In CIT v. Gangadhar Banerjee and Co. (1965) 57 ! TR 176 this Court, while dealing with the corresponding provision under the 1922 Act, held : "The Income-tax Officer, acting under this section is not assessing any income to tax: that will be assessed in the hands of the shareholder. He only does what the directors should have done. He puts himself in the place of the din:ctors. 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. He must take an overall picture of the financial position of the business''. The words ·'having regard to" used in the section do not restrict the consi\ieration only to two matters indicated in the section as it is impossible to arrive at a conclusion as to reasonableness by considering only the two matters mentioned isolated from other relevant factors. It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income- Tax Officer. The satisfaction depends upon the facts of each case.

The only guidance is his capacity to pu't himself in the position of a prudent businessman or the director of a company and his sympathetic and objective approach to the difficult problem that arises in each case. DELHI FARMING AND CONSTRUCTION (P) LTD. r. CIT [SRIKRISHNA, J. ) 47 The question which the Income-tax Officer was to ask himself was: Whether the Board of Directors of the appellant company, in deciding to transfer to capital reserve the entire amount of the awarded compensation and not distributing dividends therefrom, had acted unreasonably or as unreasonable businessman? Taken against the background of the accumulated losses of the company over several financial years, together with the loss of the only asset of the company, we are of the view that there was nothing unrei\sonable in the decision of the Board of Directors not to distribute dividends from the compensation awarded but to capitalize it in a reserve account.

In our judgment, the second statutorily required satisfaction could not have been arrived at by the Income-tax Officer so as to exercise jurisdiction under Section I04 of the Act. The third contention also succeeds. In the result, we set aside the Judgment of the High Court and uphold the order of the Income Tax Appellate Tribunal far the years 1974-75, 1975- 76 and I976-77 and answer the questions raised in favour of the assessee and against the Revenue. There shall be no order as to costs. K. K. T. Appeals allowed.