TMI Blog1978 (5) TMI 24X X X X Extracts X X X X X X X X Extracts X X X X ..... commercial profits and had been shown in the accounts as a capital reserve. The ITO did not accept the contentions of the assessee. He found that there was no prohibition in the memorandum or the articles of the assessee which barred the distribution of such gains and that the said amount was a surplus which had actually been realised. Holding that the assessee should have declared proportionate dividend out of the entire surplus including that arisen out of capital gains he passed an order under s. 23A levying additional super-tax on the undistributed amount. Being aggrieved, the assessee preferred an appeal to the AAC, where it was contended that under s. 205 of the Companies Act, 1956, dividend could be declared only out of profits. The expression "net profit" being defined in s. 349 of the Companies Act, no dividend could be declared out of capital gains. The AAC considered the definition of dividend in s. 2(1)(a) of the Companies Act (sic) and construed that it was wide enough to include capital gains. Accordingly, he confirmed the order of the ITO. There was a further appeal by the assessee to the Tribunal. It was brought to the notice of the Tribunal that the capital g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Companies Act and the law relating to companies there was no bar to capital gains being passed into the profit and loss account of a company and then distributed as dividend. He cited the following as authority for the above proposition. (a) Practical Auditing by Spicer Pegler : " The question as to whether capital profits are available for the payment of dividends, and if so, under what circumstances, is a particularly important one, and there have been two cases decided, from which it will be possible to draw some general conditions. Lubbock v. British Bank of South America [1892] 2 Ch. 198. " Held: That a profit made on the sale of a part of the undertaking of a company is available for dividend, if the articles so permit." (b) Gore-Browne on Companies : " Practical consideration as to dividends: ... in the absence of an expressly contrary provision in the articles, a company is in no way bound to distribute its profits 'up to the hilt'. It can carry such profits partly or wholly to reserve or other uses even though the articles do not expressly provide for this ...... In practice, a company is likely to impose upon itself considerably stricter restraints th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... asonable provisions for meeting losses on capital. Indeed, unless this is done, the company's auditors may find themselves unable to satisfy themselves in accordance with section 14 of the 1967 Act that the balance-sheet gives a true and fair view of the company's affairs or that the profit and loss account gives a true and fair view of the profit or loss. " "........ it is clearly established by the authorities that an accretion to fixed assets, when realised, may be brought into the profit and loss account and may be divisible profits, unless prohibited by the articles of the company, a prohibitive article of that character would, e.g., be ail article providing that dividends shall be paid out of trading profits. " (d) Spicer Pegler, 17th edn., p. 311, was cited to show that 'realised capital surpluses' can be shown in the profit and loss account or, alternatively, under reserves. Mr. Sengupta also cited a decision of the Madras High Court in Factors (P.) Ltd. v. CIT [1975] 98 ITR 105, where the Madras High Court, after considering the English law and also a decision of the Bombay High Court in CIT v. Gannon Dunkerley Co. Ltd. [1971] 79 ITR 637, differed from the latter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... luded in its income for the purpose of computation of income-tax. The ITO held that by reason of the undistributed surplus in the hands of the assessee s. 23A of the Indian I.T. Act, 1922, would apply. He rejected the contention of the assessee that the capital gains did not form part of its commercial profits. The AAC upheld the order of the ITO but the Tribunal upheld the contention of the assessee. From the order of the Tribunal there was a reference to the Bombay High Court. The High Court after considering the decision of the Supreme Court in Bipinchandra Maganlal Co.'s case [1961] 41 ITR 290 and Gangadhar Banerjee Co. [1965] 57 ITR 176 held, inter alia, as follows : " On the clear language of the section sharp distinction appears to have been made by the legislature between profits and gains of business on the one hand and capital gains on the other. Apparently, capital gains did not form part of 'the profits and/or gains of business'. Now, section 23A was part of the Income-tax Act for a continuous period of long time before the 6th head of capital gains was added in section 6 by Act XXII of 1947 ...... There was no taxation on capital gains for considerable number of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on, amount earned as capital gains must be held to be notional profits. The availability of these gains in the hands of a company does not render these gains commercial profits." Dr. Debi Pal, learned counsel for the assessee, has contended on the other hand, that capital gains accruing to a company can never be equated with its true commercial profits constituting the distributable surplus and meant to be distributed as dividend. He submitted that in the instant case it has been found that the gain accrued on sale of land which formed part of the assessee's capital and not its stock-in-trade and that it was not the business of the assessee to purchase and sell land. It had also been found that the proceeds arising out of such sale was realisation of the assessee's capital investment and not its business profits. On the authority of Gannon Dunkerley Co. [1971] 79 ITR 637 (Bom) and Bipinchandra Maganlal Co. [1961] 41 ITR 290 (SC), Dr. Pal contended that the controversy in the instant case was concluded in favour of the assessee. The decision of the Supreme Court in Bipinchandra Maganlal Co. [1961] 41 ITR 290 may conveniently be considered here. The facts in that case were ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the written down value of an asset and the price realized by sale thereof though not profit earned in the conduct of the business of the assessee is notionally regarded as profit in the year in which the asset is sold, for the purpose of taking back what had been allowed in the earlier years ...... Computation of income for purposes of assessment of income-tax is based on a variety of artificial rules and takes into account several fictional receipts, deductions and allowances. In considering whether a larger distribution of dividend would be unreasonable, the source from which the dividend is to be distributed and not the assessable income has to be taken into account ...... The legislature has deliberately used the expression 'smallness of profit' and not 'smallness of assessable income' and there is nothing in the context in which the expression 'smallness of profit' occurs which justifies 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." Relying on the aforesaid decision Dr. Pal submitted that if the differe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... commercial or accounting profits are the actual profits earned by an assessee calculated on commercial principles. Therefore, the words 'smallness of profit' in the section refer to actual accounting profits in comparison with the assessable profits of the year." Drawing inspiration from the above observations Mr. Sengupta contended that, in the instant case, capital gains came within the category of both the concepts "assessable profits" and also "accounting profit". Being assessable under s. 12B of the I.T. Act, 1922, the capital gains were assessable profits and being an actual realized gain they were also accounting or commercial profits. On a careful consideration of the authorities cited and the respective contentions of the parties, it appears to us that a capital gain cannot be equated with commercial profits. A capital gain is a notional and/or a deemed income under s. 12B of the I.T. Act, 1922, which reads as follows: " (1) The tax shall be payable by an assessee under the head 'Capital gains' in respect of any profits or gains arising from the sale, exchange, relinquishment or transfer of a capital asset effected after the 31st day of March, 1956, and such profits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lus for the purpose of distribution of dividend. It was held that in some cases a capital gain would be in the nature of the return in the capital. Without any example it is not possible to visualise in what circumstances a capital gain would be a return of capital and in what circumstances it would not be so. In our view, when a company disposes of any of its capital asset and realises a price higher than its cost price resulting in a surplus then it will be for the directors to decide if such surplus would be treated as part of the profit of the company and included in the distributable surplus. If the directors of the company decide to treat the capital gains as part of the profits of the company and the amount is put back in the profit and loss account, and thereafter if only a part of such gains is distributed as dividend, it would be open to the ITO to go into the question whether a greater proportion of such gains should have been distributed. This would be an exceptional case. But where the entire surplus is channelled into reserves it is not for the ITO to lay down that it should have been treated as profits. We agree with Mr. Sengupta that a capital gain is taxable as ..... X X X X Extracts X X X X X X X X Extracts X X X X
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