J. Dalmia vs Commissioner Of Income-Tax, New Delhi on 1 April, 1964

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

Court: Supreme Court of India

Case Number: Civil Appeal No. 505 of 1963

Decision Date: 01/04/1964

Coram: J.C. Shah, S.M. Sikri, K. Subbarao

The judgment concerns J Dalmia versus the Commissioner of Income‑Tax, New Delhi, decided on 1 April 1964 by the Supreme Court of India. The opinion was authored by Justice J C Shah, who sat with Justice S M Sikri. The parties are identified as petitioner J Dalmia and respondent the Commissioner of Income‑Tax, New Delhi. The date of the judgment is recorded as 01‑04‑1964, and the bench composition is restated as Justice J C Shah, Justice K Sikri and Justice S M Sikri. The decision is reported in the 1964 AIR 1866 and the 1964 SCR (7) 579. Citator references include 1965 SC1263, 1965 SC1862, 1970 SC 281 and 1971 SC 846. The statutory matters involved relate to company law, specifically the effect of a board resolution declaring an interim dividend, whether such a declaration creates a debt enforceable against the company, and the income‑tax consequences of the dividend under the Indian Companies Act 1913 (section 17(2), Article 95 of the First Schedule) and the Income‑Tax Act 1922 (section 16(2)).

In the facts, the appellant held shares in a company whose board of directors passed a resolution on 30 August 1950 declaring interim dividends. Subsequently, the appellant received a dividend warrant dated 28 December 1950 representing the interim dividend on the appellant’s shareholding. The appellant’s accounting year ended on 30 September 1950. The revenue authorities included the amount of the dividend in the appellant’s income for the assessment year 1952‑53, rejecting the appellant’s contention that the dividend should be treated as income of the assessment year 1951‑52. The matter was referred under section 66(1) of the Income‑Tax Act 1922, and the High Court upheld the revenue authority’s view, holding that, in view of Article 95 of the First Schedule to the Companies Act 1913, the dividend was liable to be taxed in the assessment year 1952‑53.

The Supreme Court set out several principles. First, it held that a declaration of dividend by a company in a general meeting creates a debt. This proposition was supported by the earlier case of In re Severn and Wile and Severn Bridge Railway Co. (1896) 1 Ch 559. However, the Court distinguished a mere resolution of the directors to pay a specified amount as an interim dividend, stating that such a resolution does not create a debt enforceable against the company because the directors retain the power to rescind the resolution before any payment is made. The Court cited Lagunas Nitrate Company (Ltd.) v J Henry Schroeder and Company, 17 Times Law Reports 625, and distinguished Commissioner of Income‑Tax, Bombay v Laxmidas Mutraj Khatau, 16 I.T.R. 248. Second, the Court rejected the test applied by Chief Justice Chagla in C.I.T., Bombay v Laxmidas Mulraj Khatau, 16 I.T.R. 248, which held that a dividend becomes taxable in the year of its declaration because it is due to the assessee who may deal with it as he wishes. The Court found this test inaccurate. Finally, the Court observed that a dividend may be said to be “paid” within the meaning of section 16(2) of the Income‑Tax Act 1922 when the company discharges its liability and makes the amount unconditionally available to the member entitled thereto.

The Court referred to the decision in Purshottamdas Thakurdas v. C.I.T., Bombay, reported in 34 I.T.R. 204, and also to the observation recorded at page 580 of the Supreme Court Cases, volume 17, paragraph (iv). It reiterated that a declaration of an interim dividend which remains subject to rescission by the directors does not amount to a payment within the meaning of section 16(2) of the Income‑tax Act. Such a declaration is ineffective as a payment until the company actually parts with the dividend money or otherwise satisfies the debt by a different act. The matter before the Court fell under civil appellate jurisdiction as Civil Appeal No. 505 of 1963. The appeal was filed against the judgment and order dated 6 March 1961 of the Punjab High Court (Circuit Bench) at Delhi, reported in I.T.R. No. 16 of 1959. Counsel for the appellant represented the petitioner, while counsel for the respondent, including the Attorney‑General, appeared for the revenue side. The judgment was delivered on 1 April 1964 by Justice Shah.

The appellant, a Hindu undivided family, was the registered holder of fifteen hundred shares in M/s Govan Bros. (Rampur) Ltd. for the accounting year that began on 1 October 1950 and ended on 30 September 1951. At a board meeting of Govan Bros. held on 30 August 1950, the directors passed a resolution that led to the issuance of a dividend warrant dated 28 December 1950. The warrant instructed payment of an interim dividend of four lakh twelve thousand five hundred rupees to the appellant in respect of its shareholding. The revenue authorities included this amount in the appellant’s total income for the assessment year 1952‑53, rejecting the appellant’s claim that the dividend should have been taxed in the earlier assessment year 1951‑52. The appellant then approached the Appellate Tribunal, which prepared a statement of the case and referred the pivotal question to the Punjab High Court under section 66(1) of the Income‑tax Act: whether, on a correct interpretation of Article 95 of the First Schedule to the Indian Companies Act, 1913, the dividend of Rs 4,12,500 should be charged to the assessment year 1952‑53. The High Court answered the question affirmatively. Dissatisfied with that answer, the appellant sought special leave to appeal, which was granted. Both parties agreed that Govan Bros. was incorporated under the Companies Act of the former Rampur State and that the company had adopted special Articles of Association that superseded Table A of the Companies Act. The Articles dealing with the declaration and payment of final and interim dividends were Articles 73 and 74. Accordingly, the High Court, in addressing the reference, treated the issue as one of interpreting Article 74 of Govan Bros.’ Articles of Association. It was also undisputed that the provisions of the Rampur State Companies Act were identical in substance to those of the Indian Companies Act, 1913.

In this case the appellant argued that the directors of Govan Bros. possessed authority expressly granted by article 74 of the company's Articles of Association to declare a dividend. According to the appellant, the directors exercised that authority in a meeting held on 30 August 1950 and, on that date, declared an interim dividend. The appellant maintained that, once declared, the dividend became a debt owed to the appellant and, consequently, under the Indian Income‑Tax Act the dividend should have been treated as taxable in the assessment year 1951‑52. The appellant further explained that the appellant's previous financial year ended on 30 September 1951, and therefore the dividend ought to have been assessed in the year immediately following the declaration.

The Commissioner of Income‑Tax presented a contrary position. He stated that the directors of Govan Bros. had not merely declared the dividend but had also effected payment by issuing a warrant on 28 December 1950, which was issued pursuant to the resolution dated 30 August 1950. According to the Commissioner, the dividend therefore became taxable only at the time of payment, in accordance with section 16(2) of the Indian Income‑Tax Act as it then stood. The Commissioner further explained that, under that provision, a dividend—whether final or interim—is not taxable in the year of its declaration but only in the year in which it is paid, credited, distributed, or deemed to have been so. He added that a resolution of the Board of Directors to pay an interim dividend does not create an enforceable obligation, because the directors retain the power to rescind the resolution even if it is framed in the form of a declaration of dividend.

The Commissioner also observed that the Indian Companies Act, 1913 contains no specific provision governing the declaration of dividends, whether interim or final. The Act does not specify who may declare a dividend, nor does it provide that a dividend may be declared at a general meeting of the company. However, section 17(2) of the Act permits a company to adopt any or all of the regulations contained in Table A of the First Schedule as its Articles of Association, and such adoption is deemed to incorporate regulations identical in effect to regulation 95 and regulation 97 of Table A. Regulation 95 authorises a company, at a general meeting, to declare dividends provided that the amount does not exceed the sum recommended by the directors. Regulation 97 stipulates that dividends may be paid only out of the profits of the year or any other undistributed profits. Regulation 96, which is optional, allows directors, from time to time, to pay interim dividends to members where the directors deem such payments justified by the company's profits.

Govan Bros. had, in its own Articles of Association, included specific provisions relating to dividends. Article 73 provided that the company, at a general meeting, may declare a dividend to be paid to members in proportion to their rights and interests in the profits. Article 74 stated that, when the directors considered that the company's profits permitted, they could declare an interim dividend. Article 77 required that no dividend be payable except out of the net profits arising from the business of the company, and that no dividend be larger than the amount recommended by the directors. These provisions formed the basis for the appellant’s reliance on the directors’ authority to declare the dividend, while the Commissioner relied on the statutory requirement that tax liability arise only upon actual payment of the dividend.

Article 80 of the Articles of Association stipulated that, unless the company directed otherwise in a general meeting, any dividend could be paid by means of a cheque or a warrant that was mailed to the registered address of the member who was entitled to receive it. Article 74 dealt with the payment of interim dividends and showed a small but important difference from the regulation contained in Table A of the First Schedule to the Companies Act. Under regulation 96 of Table A, the directors were authorised to pay interim dividends to the members, whereas Article 74 of Govan Bros.’ Articles of Association authorised the directors only to declare an interim dividend. It was also observed that Section 17 made clear that the adoption of an article that was identical to, or had the same effect as, regulation 96 of Table A was not compulsory.

The substantive portion of Section 16(2) of the Income‑Tax Act, as it existed before being repealed by Section 7 of the Finance Act, 1959 with effect from 1 April 1960, read as follows: “For the purposes of inclusion in the total income of an assessee 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.” In other words, a dividend was to be treated as income of the year in which it was actually paid, credited, distributed, or deemed to have been so dealt with. In the case presently before the Court, a dividend was paid to the appellant on 28 December 1950. The appellant asserted that the dividend amount had neither been credited in the books of Govan Bros. to his account nor been distributed, or deemed to have been paid, credited or distributed to him before the close of his accounting year, which ended on 30 September 1950.

Mr Kapur, counsel for the appellant, argued that under company law, when a dividend—whether interim or final—is declared, it becomes due at the moment of declaration and, for the purposes of the Income‑Tax Act, should be regarded as having been paid to the member on the declaration date. The Court noted that there is no dispute that a declaration of dividend by a company at a general meeting creates a debt. As stated in the precedent In re Severn and Wye and Severn Bridge Railway Company, “When a company declares a dividend on its shares, a debt immediately becomes payable to each shareholder in respect of his dividend for which he can sue at law, and the Statute of limitation immediately begins to run.” However, the Court emphasized that this rule applies solely to dividends declared by the company in a general meeting. A final dividend is generally sanctioned at an annual meeting when the accounts are presented to the members. In contrast, the authority to pay an interim dividend is normally vested, by the articles of association, in the directors, and the payment of an interim dividend does not require a resolution of the company provided that the directors have been authorised to do so.

By virtue of the articles of association, the directors possessed authority to pay an amount that they deemed appropriate, having regard to their estimate of the profits earned by the company. Consequently, an interim dividend was paid pursuant to a resolution of the directors on a day that fell between the ordinary general meetings of the company. When the dividend was actually paid, it unquestionably became the property of the shareholder who was entitled to receive it. Nevertheless, a mere resolution of the directors that authorised the payment of a specified amount as interim dividend did not create a debt that could be enforced against the company, because the directors always retained the power to rescind that resolution prior to the actual payment of the dividend.

In the case of The Lagunas Nitrate Company (Limited) v. J. Henry Schroeder and Company (2), the directors passed a resolution declaring an interim dividend payable on a future date and instructed the company’s bankers to set aside, from the company’s funds in their possession, a sum sufficient to cover the dividend into a special account titled “interim Dividend Account”, pending further instructions from the company. However, before the date fixed for payment arrived, the directors resolved that, because of certain litigation to which the company was a party, the payment of the dividend should be postponed. The Court held that the directors retained the right, even after having resolved to pay the interim dividend, to rescind that resolution, and that no enforceable right vested in the members of the company by the declaration of the interim dividend.

Halsbury’s Laws of England, III Edn., Vol. 6 p. 402, Art. 778, stated that “A directors’ declaration of an interim dividend may be rescinded before payment has been made.” (1) (1896) 1 Ch. 559. (1) 17 Times Law Reports 625. Accordingly, a declaration of dividend made by the company in a general meeting gave rise to an enforceable obligation, whereas a resolution of the Board of Directors to pay an interim dividend, or even a resolution to declare an interim dividend under the authority granted by the articles of association, did not create an enforceable obligation against the company, because the resolution could always be rescinded.

The deviation in the wording of Article 74 of the Articles of Association of Govan Bros. from the statutory version contained in Table A concerning the power to deal with interim dividends entrusted to the directors made no material difference to the nature of any right that might arise in favour of the members upon exercise of that power. The directors, under the articles, were entrusted with the administration of the company’s affairs and, if authorised, could declare an interim dividend. They were free to pay such dividend, even when the company’s financial situation justified the payment, but they were under no compulsion to do so. Even after a resolution to pay an interim dividend had been passed, the directors retained the ability to rescind the resolution before any payment was made. Counsel for the appellant did not rely upon any evidence of actual payment or upon any credit given to the appellant in the books of account of

The Court observed that there was no record of a resolution of the directors dated 30 August 1950, and no evidence showed that any resolution to pay the dividend had been made for a date prior to the actual payment. Moreover, the company had not taken any step to implement such a resolution within the financial year that corresponded to the assessment year 1951‑52. The Court further noted that no statutory provision creates a legal fiction whereby the mere declaration of an interim dividend is deemed to have been paid, credited or distributed.

In support of the claim that the interim dividend should be taxed in the assessment year 1951‑52, the appellant relied only on two factual propositions: first, that the directors possessed the power to declare an interim dividend; and second, that the directors had passed a resolution concerning the interim dividend on 30 August 1950, which was followed by the issue of dividend warrants dated 28 December 1950. The Court reiterated that, for the reasons already stated, a resolution of the board of directors declaring an interim dividend does not, by itself, create an enforceable right in the shareholders until the company takes some subsequent step to give effect to that resolution.

The Court examined the judgment cited by counsel for the appellant, namely Commissioner of Income‑Tax, Bombay v. Laxmidas Mulraj Khatau, reported in 16 I.T.R. 248. In that case the company declared a dividend out of its profits and made the dividend payable a few days later. The dividend was considered paid on the date on which a resolution of the company made it payable. The Income‑Tax Officer treated the amount received by the member as dividend income for the assessment year in which the amount was actually received.

In a reference under section 66, the Bombay High Court observed that as soon as a dividend was declared it became the income of the assessee, and the assessee could deal with that income in any manner he chose. Chief Justice Chagla, speaking for the Court, explained the proper construction of the word “paid” in subsection (2) of section 16. He stated that a literal construction would require the dividend warrant to be actually cashed and the dividend amount to be realised before the dividend could be said to be paid to the shareholder. Instead, he held that when a dividend is declared, a liability arises on the part of the company to make the payment, and for the shareholder the income represented by that dividend accrues at the moment of declaration. The mere fact that actual payment is deferred is immaterial and irrelevant.

Finally, the Court emphasized that the question of whether an interim dividend or a fixed dividend is taxable in a particular assessment year must be determined according to the provisions of section 16(2) of the Indian Income‑Tax Act.

The Court observed that the legislature had not provided for dividend income to be taxed in the year it became due; instead, the statute expressly required that dividend income be taxed only in the year in which it was paid, credited, distributed, or deemed to be so. The legislature, however, had framed distinct rules for determining the year of taxation for each head of income. Under section 7, salary became taxable when it was allowed to the employee or when it became due to him, irrespective of whether it was actually paid. Section 8 provided that interest on securities was taxable at the time it was received by the assessee. According to section 9, tax on property was not contingent on actual receipt of income but was payable based on a national computation of the property’s bona‑fide annual value for the year of account, subject to the adjustments specified in that section. Profits and gains of business, profession or vocation were to be computed in the manner of accounting regularly employed by the assessee, unless the Income‑Tax Officer, on the view that profits could not be properly deduced by that method, directed a different approach. Other sources of income, including dividends, were placed in the residuary class and were to become taxable in the year in which they were received, accrued, arose, or were deemed to be received, accrued or arisen, depending on the nature of each particular income. Consequently, the year in which a specific class of income became taxable had to be determined by examining its true character and by applying any special provision that might apply. The legislature had enacted an explicit provision that made dividend income taxable in the year it was paid, credited, distributed, or deemed to be so. The test adopted by Justice Chagla, which held that because a dividend became due to the assessee, who then had the right to deal with it as he wished, it should be taxed in the year of declaration, was therefore considered incorrect. While it was true that the word “paid” in section 16(2) did not require the dividend to be actually received by the member, the Court explained that, in general, a dividend could be regarded as paid within the meaning of section 16(2) when the company discharged its liability and made the dividend amount unconditionally available to the entitled member. Justice Chagla, however, had expressed a contrary view in Purshotamdas Thakurdas v. Commissioner of Income‑Tax, Bombay City, where he referred to the decision in Laxmidas Mulraj Khatau’s case and noted that the principle in that case applied only where, on the facts, the dividend had been paid to the shareholder and not where a contingent liability existed without any actual payment. He further observed that the language used by the legislature was clear that it did not intend to equate “paid” with “declared” in every circumstance.

In the present case, the Court observed that the Legislature did not intend to make the terms “paid” and “declared” identical in every circumstance. Accordingly, the Court held that it could examine, despite the authority of the Khatau Mills case, whether the facts before it demonstrated that a dividend could be characterised as paid even though it had been declared, but might never become payable and, in reality, had not been paid. The Court further explained that if a simple declaration of a dividend by the company in a general meeting is not regarded as payment for the purposes of section 16(2), then a resolution declaring an interim dividend, which remains subject to rescission by the directors, cannot be treated as payment before the company has actually transferred the dividend amount or otherwise discharged the related obligation. On that basis, the Court agreed with the High Court’s finding and accepted the affirmative answer that had been recorded to the question presented for its consideration. Consequently, the Court dismissed the appeal, ordered that the appeal fail and directed that costs be awarded against the appellant. The order therefore concluded with the appellate court dismissing the appeal. The citation to the decision appears in the first volume of the Income Tax Reports at page 204.