The Commissioner Of Income-Tax, Bombay vs The Jalgaon Electricity Supply Co., Ltd

Rewritten Version Notice: This is a rewritten version of the original judgment.

Court: Supreme Court of India

Case Number: Civil Appeal No. 477 of 1957

Decision Date: 04/05/1960

Coram: M. Hidayatullah, S.K. Das, J.L. Kapur

In the case styled The Commissioner Of Income‑Tax, Bombay v. The Jalgaon Electricity Supply Co., Ltd, decided on 4 May 1960, the Supreme Court of India heard arguments before a bench comprising Justice M. Hidayatullah, Justice S. K. Das and Justice J. L. Kapur, with the judgment authored by Justice M. Hidayatullah. The petition was filed by the Commissioner of Income‑Tax, Bombay and the respondent was the Jalgaon Electricity Supply Company, Ltd. The judgment bears the citation 1960 AIR 1182 and is reported in D 1961 SC 699, R 1968 SC 623 and other law reports. The legal issue concerned whether an additional income‑tax could be levied on excess dividends when there were no profits carried forward from preceding years, and what manner of calculation the Indian Finance Acts of 1949 and 1950 prescribed under paragraph B of Part 1 of the First Schedule.

The factual matrix, as summarized in the headnote, showed that after making all allowances and deductions, the assessor’s company was assessed for the fiscal years 1949‑50 and 1950‑51 at Rs. 3,423 and Rs. 3,312 respectively. During those two years the company declared dividends of Rs. 46,024 and Rs. 56,326. Although the company had not brought forward any profits from earlier years, the income‑tax officer applied the proviso to paragraph B of Part 1 of both the Third and First Schedules of the Finance Acts of 1949 and 1950. The officer assessed the difference in each year as additional income‑tax and levied tax at the rate of five annas in the rupee on the amounts for the two assessment years. The Bombay High Court held that despite the actual payment of excess dividends, the absence of any profits from previous years rendered the provision of the Finance Act inapplicable in the present circumstances.

The Supreme Court was called upon to determine whether the second proviso to paragraph B, read with its explanatory note, intended to impose the additional income‑tax on excess dividends even when there were no profits carried forward from preceding years. The Court held that the second proviso to paragraph B of Part 1 of the First Schedule of the Finance Act 1950, which mirrors the corresponding provision of the Finance Act 1949, creates a legal fiction. This fiction assumes that there must exist undistributed profits of one or more years immediately preceding the year of assessment, that such undistributed profits must be sufficient to cover the amount of excess dividend actually paid out in the year under assessment, and that the same undistributed profits may not be used to cover excess dividends of any other prior year. Accordingly, excess dividends must first be linked to the profits of the preceding years, the tax borne on those profits must be determined, and the additional tax payable is the difference between the tax actually paid on those profits and the tax demanded under the provision. Where no profits exist in any preceding year, the fictional premise collapses entirely, and the method of calculation prescribed by the provision cannot be applied. The Court further held, in continuation of this reasoning, that the income‑tax…

The Court explained that the statute attempted to bring a defined category of receipts within the net taxable income, and that such a result could be achieved only if the legislation contained a provision expressly designed to accomplish that purpose. The Court further observed that if the legislative provision failed to encompass a particular taxpayer, and that taxpayer therefore could not be subjected to the statutory requirement, no claim of injustice could arise against the law.

In this appeal, identified as Civil Appeal No. 477 of 1957, the appellant sought review of a judgment and order dated 9 September 1955 pronounced by the Bombay High Court in Income‑tax Reference No. 37/x of 1954. The appellant was represented by counsel, while the respondent was represented by counsel on the other side. The appeal was heard on 4 May 1960, and the judgment was delivered by Justice Hidayatullah.

The appeal was filed against a certificate that the High Court had granted, confirming its earlier decision. The certificate related to a reference made under section 66(1) of the Indian Income‑tax Act. The Tribunal had posed two questions for the High Court’s determination: first, whether the assessee company had declared any dividend in excess of the amount permissible under the statute; and second, whether the assessee company was liable to pay additional income‑tax on that excess dividend.

The High Court answered the first question affirmatively, holding that an excess dividend had indeed been declared, but answered the second question negatively, concluding that no additional tax liability arose. The appellant in this proceeding was the Commissioner of Income‑tax, Bombay, and the respondent was the Jalgaon Electric Supply Co., Ltd., described in the records as the assessee company.

The factual background was straightforward. For the assessment years 1949‑50 and 1950‑51, the company's book profits were Rs 1,22,469 and Rs 76,886 respectively. After allowing for depreciation and other permissible deductions, the assessable income for those years was reduced to Rs 3,423 and Rs 3,312 respectively. The company then declared dividends of Rs 46,024 for the first year and Rs 56,326 for the second year.

The Income‑tax Officer applied the proviso to paragraph B of Part 1 of the Third and First Schedules of the Finance Acts of 1949 and 1950 respectively, and assessed the portion of dividend that exceeded the statutory limit as additional taxable income. The officer levied tax on that amount at the rate of five annas in the rupee for each of the two assessment years.

The assessee company first appealed to the Appellate Assistant Commissioner and subsequently to the Tribunal. Within the Tribunal, the President and the Accountant Member disagreed: the President held that the company was not liable for the additional tax, while the Accountant Member held that it was. The dispute was referred to a third Member, who concurred with the President.

The majority of the Tribunal based its decision on the observation that there were no undistributed profits carried forward from the years preceding the previous year, and therefore the statutory paragraph could not be applied in the circumstances. The minority opinion argued that, even in the absence of such profits, the intention of the Finance Act to impose additional tax on excess dividends was clear, and consequently the company should be liable. The Court noted these contrasting views before proceeding to its own analysis.

The Court observed that the Tribunal’s decision was based entirely on the fact that the company had not carried forward any profits from earlier years, and consequently the provisions of the relevant Paragraphs could not be applied. The High Court likewise held that although the company had actually paid excess dividends, the lack of any profits from the preceding years made the Finance Act ineffective in the present situation. Accordingly, the High Court accepted the reasons given by the Tribunal and affirmed its decision.

Paragraph B of Part 1 of the First Schedule of the Finance Act, 1950 is identical to the corresponding Paragraph in the Finance Act, 1949, and therefore it was unnecessary to discuss both statutes separately. The Court therefore confined its analysis to the Finance Act, 1949. It was further noted that the factual circumstances of the two assessment years were essentially comparable, the only difference being the amounts of income and the excess dividends involved.

The wording of the Paragraph was set out as follows: “B. In the case of every company—Rate on the whole of total income … five annas in the rupee: Provided that in the case of an Indian company— (i) where the total income, after reducing it by seven annas in the rupee and by any amount exempt from income‑tax, exceeds the amount of any dividends (including dividends payable at a fixed rate) declared in respect of the whole or part of the previous year for the assessment year ending on the 31st day of March, 1950, and where an order has been made under sub‑section (1) of section 23A of the Income‑tax Act, a rebate shall be allowed at the rate of one anna per rupee on the amount of such excess; (ii) where the amount of dividends referred to in clause (i) above exceeds the total income after the same reductions, an additional income‑tax shall be charged on the total income equal to the shortfall, if any, between the aggregate amount of income‑tax actually borne by such excess dividend (hereinafter referred to as ‘the excess dividend’) and the amount that would be calculated at the rate of five annas per rupee on the excess dividend.”

For the purposes of the above proviso, the term ‘dividend’ was to have the meaning assigned to it in clause (6A) of section 2 of the Income‑tax Act, but any distribution included in that definition that was made during the year ending on the 31st day of March, 1950, would be deemed to be a dividend declared in respect of the whole or part of the previous year. For the purpose of clause (ii) of the proviso, the aggregate amount of income‑tax actually borne by the excess dividend was to be determined as follows: (i) the excess dividend would be deemed to arise out of the whole, or such portion of, the undistributed profits of one or more years immediately preceding the previous year as would be just sufficient to cover the amount of the excess dividend, and …

It was stated that the portion of the excess dividend which was deemed to arise from the undistributed profits of each year would be treated as having borne tax, provided that (a) an order had been made under sub‑section (1) of section 23A of the Income‑tax Act in respect of the undistributed profits of that year, in which case the tax rate of five annas in the rupee applied, and (b) for any other year the tax rate applicable to the total income of the company for that year, reduced by the rebate rate, if any, allowed on the undistributed profits, applied. The Court explained that the scheme of the Finance Act relating to excess dividends and their liability to additional income‑tax had already been examined in Civil Appeal No. 427 of 1957, a decision delivered on the same day. In the present case the Court was concerned with the application of the second proviso to the paragraph, together with the explanatory notes that set out the method of calculating the tax. As had been pointed out in the earlier case, additional income‑tax became payable when dividends exceeding the statutory limit were distributed in any year. This additional tax was to be calculated after taking into account any tax that might have already been paid on the profits, even if that tax had been levied at a lower rate in a previous assessment year, and a deduction for that amount was allowed. The additional tax was therefore payable on the excess dividends at a higher rate, but reduced by the tax already borne. To determine the aggregate amount of tax to be borne by the excess dividends, the paragraph prescribed a specific procedure. First, the excess dividend was to be deemed to be drawn out of the whole or a portion of the undistributed profits of one or more years immediately preceding the previous year, sufficient to cover the amount of the excess dividend and not previously used to cover an excess dividend of an earlier year. Then, each portion of the excess dividend deemed to arise from the undistributed profits of a particular year was to be treated as having borne tax according to the rules just described. The Court noted that these fictions required the existence of undistributed profits in one or more years immediately before the previous year, that such profits be sufficient to meet the amount of the excess dividend actually paid in the assessment year, and that those profits not have been previously employed to satisfy an excess dividend of any other year. Where no such profits existed in any preceding year, the fictional construct failed entirely, and so did the method of calculation. The Court therefore rejected the Commissioner’s argument that the fiction could be given effect even when profits of preceding years did not exist.

It was observed that profits of the preceding years did not exist. The argument advanced by the Commissioner suggested that, even in the absence of such profits, the excess dividends could still be liable to additional income‑tax under the terms of the Paragraph. However, a plain reading of the Proviso demonstrated that the excess dividend first had to be linked to profits of the preceding years, and only after identifying the tax that had been borne on those profits could the additional tax be calculated. The additional tax was to be payable at a higher rate and was measured by the difference between the tax actually paid on the profit and the tax that would be demandable under the Paragraph. The High Court had rejected the Commissioner’s argument in a manner similar to the approach adopted by this Court, and the Court fully agreed with the reasons given by the High Court. The Accountant Member, whose opinion formed a minority, advanced two specific reasons. The first reason stated that “ the explanation provides for the determination of the years out of the profits of which the excess dividend has come ”. The second reason asserted that “ in order to escape the liability imposed by Cl. (ii), the company must prove that the excess dividend has borne tax 5 annas in the rupee as it is only in that event that the additional tax payable will be nil ”. Both of these reasons were placed before the Court for consideration. The Court, however, could not accept them. It held that the fiction underlying the provision could not be narrowed as suggested in the first reason, because the fiction not only contained the Accountant Member’s description but also embedded a mode of calculation that was not part of the fiction itself. The Court explained that the mode of calculation could not be given effect, and further opined that the fiction failed altogether since there were no profits of any preceding years. Regarding the second reason, the Court observed that it presumed the liability to pay tax, which was impermissible because the existence of such liability was the very issue to be decided. The Court stressed that this factual question could be resolved only if the Paragraph could be applied to the present case; it could not be assumed that additional income‑tax on the excess dividend was payable irrespective of the applicability of the Paragraph, as such an assumption would beg the very question under consideration. The Commissioner had also proposed numerous modifications to the language of the provision in order to give effect to the intention of levying additional income‑tax on excess dividends, and, similar to the Accountant Member, argued that it would be unjust to allow a company to escape tax when there were no profits of preceding years against which the excess dividend could be set off. The Court concluded that the issue of modifying the language could not arise in the circumstances of the case. It referred to the reasons previously articulated in Civil Appeal No. 427 of 1957, decided on the same day, and indicated that further discussion was unnecessary. The Court also noted that there was no question of unjustness, because the income‑tax law could bring only those classes of income within its net that the statute expressly provided for, and if the law failed to do so, the taxpayer could not be compelled to pay tax beyond its scope.

The Court explained that the income‑tax law is designed to bring a particular class of income within its net, but it can achieve that purpose only when the statute contains a provision that is suitably framed for that end. When the legislative provision is defective or does not extend to the taxpayer because its wording is insufficient, the law simply cannot be applied to that person, and no claim of injustice arises from the failure of the statute to capture the taxpayer. In other words, if the law fails and the taxpayer cannot be brought within its literal terms, the situation does not give rise to any notion of unfairness. The Court then turned to the findings of the High Court, noting that the High Court had answered two specific questions that had arisen in the proceedings. The Court held that the answers given by the High Court to those two questions were correct in view of the facts and the legal context of the case. Accordingly, the Court concluded that the appellant’s challenge could not succeed. The appeal therefore failed, and the Court ordered that it be dismissed. In addition, the Court directed that the costs of the proceedings be awarded against the appellant. The final disposition was that the appeal was dismissed.