Kishinchand Chellaram vs Commissioner Of Income-Tax, Central

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

Court: Supreme Court of India

Case Number: Nos. 462 to 465 of 1960

Decision Date: 19 April, 1962

Coram: J.C. Shah, S.K. Das, M. Hidayatullah

In the matter titled Kishinchand Chellaram versus the Commissioner of Income‑Tax, Central, the Supreme Court of India delivered its judgment on 19 April 1962. The judgment was authored by Justice J. C. Shah, who sat with Justices S. K. Das and M. Hidayatullah. The petitioner was Kishinchand Chellaram and the respondent was the Commissioner of Income‑Tax, Central, Bombay.

The case concerned a private limited company, Chellsons Ltd., which had declared dividends without first providing for the company’s tax liability, including the Extra Profits Tax imposed under the Indian Income‑Tax Act, 1922. The dividends were entered as credits in the company’s books against the accounts of each shareholder. In the assessment year that corresponded to the dividend declaration, the shareholders reported the credited amounts in their income‑tax returns as dividend income.

At the time of the dividend declaration, the payment of dividends out of any source other than the profits of the year or other undistributed profits was prohibited by Article 97 of Table A of the Indian Companies Act, 1913, as amended by Act XXXII of 1936 and by section 17(2) of that Act. Consequently, the payment could not be regarded as lawful because the company had failed to provide for the payment of tax before declaring the dividend.

After the error was discovered, the company convened an extra‑ordinary general meeting in which a resolution was moved to reverse the earlier dividend resolutions. All shareholders, fully aware of the genuine mistake, unanimously resolved that the dividends which had been inadvertently paid should be treated as loans to the individual shareholders.

The shareholder‑assessees did not file revised tax returns before the Income‑Tax Officer, nor did they assert that the amounts received were exempt from tax. On appeal before the Appellate Assistant Commissioner, each assessee argued that, in view of the subsequent resolution, the amounts credited to their accounts should not be taxed as dividend income. The Assistant Commissioner rejected this contention.

Subsequently, before the Tribunal, the assessee contended that the dividends had been declared out of capital and that such a declaration was invalid under the Companies Act. The Tribunal held that a later resolution could not transform a payment that had been made and received as a dividend into a loan; the character of the payment remained that of a dividend.

The High Court affirmed the Tribunal’s decision, observing that each year’s assessment is self‑contained and that later events cannot be used to alter an assessment that has already been made. The assessee then appealed to the Supreme Court. The Supreme Court held that where the directors of a company deliberately or negligently cause the payment of dividends out of capital, such conduct may give rise to liability for the company or, in the event of winding up, may permit the liquidator to seek compensation for loss caused by the wrongful or negligent conduct.

The Court explained that when a company is placed under liquidation, the liquidator may institute proceedings against directors who have caused loss to the company by acts that are either wrongful or negligent, with a view to recover compensation for that loss. The principle was illustrated by reference to the earlier decision in Matter of The Union Bank, Allahabad Ltd. (1925) I.L.R. 47 All. 669, which was affirmed as authority. The Court further held that, for the purpose of determining whether liability to pay income tax on a dividend arises, a subsequent corporate resolution that attempts to re‑characterise payments that were made to shareholders as dividends into loans cannot retroactively change the nature of those payments. Consequently, such a re‑characterisation cannot relieve the shareholders of tax liability that has already attached to the dividend at the time of its distribution. The Court also reiterated that a dividend retains its character even when it is paid out of the company’s capital, and that under the Income Tax Act the liability to pay tax arises as soon as a dividend is paid, credited, distributed or declared. The statute does not envisage an inquiry into whether the dividend was properly paid, credited or distributed before the tax liability attaches.

The matter before the Court involved a group of appeals filed against orders of the Bombay High Court in an income‑tax reference brought under section 66(1) of the Indian Income Tax Act. The appellant company, Chellsons Ltd., was a private enterprise incorporated in April 1941. At the relevant time, its shareholding consisted of Kishinchand Chellaram, who owned six shares, and three other individuals—Shewakram Kishinchand, Lokumal Kishinchand and Murli Tabilram—each holding three shares. The latter three were also directors of the company. On 10 July 1943, a general meeting of shareholders resolved to declare a dividend at the rate of sixty per cent on the shares, and for that purpose the profits of the financial year 1941‑43 were included in the profit calculation for the year 1942‑43. Pursuant to this resolution, the company’s books recorded a credit of Rs 46,000 to the account of Kishinchand Chellaram on 31 March 1944, and a credit of Rs 23,000 to each of the other three shareholders. A subsequent general meeting on 15 July 1944 resolved to declare another dividend at sixty per cent on the shares, this time out of the profit of the year 1943‑44. Accordingly, on 29 September 1944 the company’s accounts showed a credit of Rs 30,000 to Kishinchand Chellaram and Rs 15,000 to each of the remaining shareholders. In the income‑tax returns filed for the assessment year 1945‑46, the four individuals—collectively referred to as the assessees—included in their returns the amounts that had been credited to them in the company’s books as dividends for the three financial years 1941‑42, 1942‑43 and 1943‑44.

On December 4, 1947, the company convened an Extraordinary General Meeting at which a resolution was passed purporting to reverse the earlier resolutions dated July 10, 1943 and July 15, 1944. The resolution was recorded as follows: “The notice dated 25 November 1947 calling the Extraordinary General Body Meeting for today was placed on the table. Whereas the sum of Rs 1,90,000 paid to the shareholders during the year 1944‑45 as per details given below viz‑ 1941‑42 1942‑43 1943‑44 Total – Mr Kishinchand Chellaram 10,000 36,000 30,000 76,000; Mr Shewakram Kishinchand 5,000 18,000 15,000 38,000; Mr Lokumal Kishinchand 5,000 18,000 15,000 38,000; Mr Murli Tahilram 5,000 18,000 15,000 38,000; Total 25,000 90,000 75,000 190,000 – was sanctioned by the General Body inadvertently without taking into consideration the Company’s liability for taxation, including EP T, and all the shareholders having been fully apprised of the bona‑fide mistake. It is hereby unanimously resolved that such dividend inadvertently paid be considered as loan to such individual shareholders and be paid back to the Company forthwith, and the consideration of any dividend to the shareholder be deferred to the next Annual General Meeting. The adjustment in this regard will not be made in the books of the Company as on 6 April 1947.” Although this resolution was adopted, the assess­sees did not file revised returns that excluded the amounts that had been credited to them as dividends, nor did they approach the Income Tax Officer to claim that those amounts, being deemed loans, were not taxable income. By an order dated 1 January 1950, the Income Tax Officer assessed the returns of the assess­sees, including the amounts credited as dividends for the three years 1941‑42, 1942‑43 and 1943‑44, and brought them within the charge of tax. The assess­sees appealed to the Appellate Assistant Commissioner, contending that, in view of the subsequent resolution, the sums credited to their accounts for the years 1941‑42, 1942‑43 and 1943‑44 should not be treated as dividend income liable to tax. The Appellate Assistant Commissioner rejected this contention. The assess­sees then appealed to the Income Tax Appellate Tribunal, arguing that the dividends for the three years were declared out of capital and that such a declaration was invalid under the Indian Companies Act; consequently, the amounts credited as dividends should be excluded from assessment. The Tribunal held that the dividends for the years 1941‑42 and 1942‑43 had been received before the relevant year of account for the assessment year 1945‑46 and therefore were not taxable in that year. However, the Tribunal affirmed the assessment for the dividend of the year 1943‑44, reasoning that a resolution passed at a later General Meeting could not reverse a dividend declaration that had already been paid. At the request of the assess­sees, the Appellate Tribunal referred each of the four cases for further consideration of two specific questions.

The issues placed before the Tribunal were framed as two questions. The first question asked whether the shareholders who met on 4 December 1947 possessed the authority to overturn the resolutions that had been passed on 10 July 1943 and on 15 July 1944. The second question inquired whether the amount of rupees that had been received by a particular assessee as dividend in the accounting year 1944‑45, which was relevant to assessment year 1945‑46, had been lawfully taxed in that assessment year. The second question further sought a clarification: if the taxation was not lawful, could only those portions of the dividend that could be shown to have been paid out of profits, or part of the profits, be taxed for assessment year 1945‑46? In each set of questions the specific sum received and the name of the assessee were inserted into the second part of the question.

The Tribunal, in its order of reference, observed that the Income Tax Department had contested the correctness of the shareholders’ claim that the dividend had been paid without any provision being made for tax. However, the Department did not wish to examine the accounts to determine whether a tax provision had been created. The Tribunal recorded the Department’s position as follows: the parties, at the time of hearing, proceeded on the basis that no such provision had been made, and even if a provision had been made, it would make no difference to the Department’s case. The core issue, according to the Tribunal, was whether any dividend had been declared out of capital. That issue, the Tribunal said, had to be examined when passing the order under Section 66(5) of the Act, in light of question No 2.

The High Court chose not to answer the first question, holding that it was unnecessary to do so. It answered the first part of the second question in the affirmative, i.e., it held that the dividend in question had been lawfully taxed. The Court then held that the second part of the second question did not arise for decision on that view. dissatisfied with the High Court’s decision, the four assessees filed appeals. The only point of material importance in those appeals, as argued before the Tribunal, was whether the company could, by a later resolution, reverse an earlier resolution that had declared a dividend.

The Tribunal ruled that a later resolution could not reverse an earlier resolution declaring a dividend. Consequently, any amount that had been paid and received as a dividend could not, by a subsequent company resolution, be treated as having been paid in any manner other than as a dividend. The High Court, on the other hand, held that the assessments made by the Income Tax Officer were proper. It observed that the assessment of each assessee for a particular year is self‑contained and that later events cannot justify altering that assessment. Section 16(2) was noted, insofar as it was material, stating that for the purpose of inclusion in an assessee’s total income, any dividend shall be deemed to be income of the previous year in which it is paid, credited, or distributed, or deemed to have been paid, credited, or distributed to him. It was agreed by all parties that on 15 July 1944 the company had passed a resolution declaring a dividend, and that the amounts payable to the assessees had, in fact, been credited to their accounts.

On September twenty‑nine, 1944, the company’s accounts showed that a sum was credited to each shareholder and recorded as a dividend. Consequently, the amounts were declared to be dividends, treated in the accounts as dividends, and actually received by the assessors in the character of dividends. Each assessor then incorporated the credited amounts into his income tax return as dividend income. It may be assumed that, prior to declaring the dividend, the company did not first set aside the tax liability, and that after making provision for tax, the company’s net profits were insufficient to support a dividend equal to sixty percent of the share value. On that assumption, it can be inferred that the dividend, or a portion of it, was in fact paid out of the company’s capital. At the material time, payment of a dividend out of capital rather than out of current year profits or other undistributed profits was prohibited by Article ninety‑seven of Table A of the Indian Companies Act, 1913, as amended by Act XXXII of 1936, read with section seventeen‑two of that Act; therefore such a payment could be characterised as unlawful. If the directors of a company deliberately caused, or were negligently instrumental in causing, a dividend to be paid out of capital, they may be liable, in an action by the company—or, if the company is being wound up by the liquidator—to compensate the company for the loss resulting from their wrongful or negligent conduct, as noted in the matter of The Union Bank Allahabad Ltd. (1925) I.L.R. 47 All. 669. In the present case, the court is not concerned with the validity of the dividend distribution itself, nor with any liability of the directors arising from an improper distribution. The focus is on the true nature of the payment made on September twenty‑nine, 1944, to the assessors. The question posed is whether, once a dividend has been declared and the amount credited or paid to shareholders as a dividend, the character of that credit or payment can be altered by a subsequent resolution so that the tax incidence attached to it is changed. By virtue of section sixteen‑two of the Income‑Tax Act, the liability to pay tax arises at the moment the dividend is paid, credited, distributed, or deemed to have been so to the shareholders, and the Act contains no provision allowing the tax incidence to be altered merely because the company’s payment of the dividend later is found to have contravened a statutory prohibition. It is unnecessary to consider whether the shareholders might be compelled by the company to return the amount that was improperly paid as a dividend out of capital. Even if the shareholders agree to refund the amounts received as dividend, the original character of the receipt as a dividend remains unchanged. In determining whether liability to pay income tax on the dividend arose, a resolution of the company that re‑characterises the payments made to shareholders as dividends and treats them instead as loans cannot retroactively alter the nature of the payment and therefore cannot exempt it from the tax liability that has already attached.

In this case the Court observed that the character of a payment cannot be altered retrospectively in order to remove the tax liability that has already attached to it. Two distinct submissions were advanced before the Court by counsel for the assessors. The first submission contended that the amount received by each assessee should not be subject to tax because, according to that argument, the receipt was not a dividend at all. The second submission asserted that the amount which had been declared and distributed as a dividend ceased to be a dividend after the company passed a later resolution treating the payment as something else. The Court noted that the first submission had never been presented to the Tribunal, and that, given the way the question was framed, it did not arise for decision in the reference made under section 66 of the Indian Income‑Tax Act. Because the jurisdiction of the High Court under section 66 is advisory, the High Court was limited to giving its opinion on questions that fairly arose from the Tribunal’s order and that were actually referred to it. Accordingly, the issue of whether the payment made by the company was not in the nature of a dividend had not fairly arisen from the Tribunal’s order and therefore could not be raised before this Court, just as it could not have been raised before the High Court. The Court further held that, in its view, a payment made by a company to its shareholders as a dividend does not lose the character of a dividend merely because it is paid out of capital. Under the Income‑Tax Act, liability to pay tax attaches at the moment a dividend is paid, credited, distributed or declared, and the Act does not contemplate an inquiry into whether the dividend was properly paid, credited or distributed before that liability attaches. Regarding the second submission, the Court reiterated the reasons previously given and concluded that the answer to that contention must be negative. Consequently, the appeals were dismissed. In view of the circumstances, no order as to costs was made, and the appeals were dismissed.