Judgment:
K. Shivashankar Bhat, J.
1. In all these three reference, an identical question has been referred for our consideration under section 256(1) of the Income-tax Act, 1961 ('the Act' for short), which reads as follows :
'Whether, on the facts and in the circumstances of the case, the explanation by the assessee that dividends were not declared in view of the expansion programme of the company, was not available to the assessee as a defence against application of section 104(1) in view of section 107A, Income-tax Act ?'
2. The assessment years are 1981-82, 1982-83 and 1983-84.
3. The assessee which is a company has not declared any dividend during the relevant under section 104 of the Act though it had distributable income. The assessee stated that the income was not distributed, having regard to the expansion programme of the company to set up a distillery plant at Shimoga. However, the company had not applied under section 107A of the Act to the Board. Instead, it sought to explain the reason for non-declaration of dividend under section 104(2) of the Act. This explanation was not accepted on the ground that, according to the Inspecting Assistant Commissioner, the company had earned substantial profits during the relevant years. The Commissioner of Income-tax (Appeals) also took a similar view.
4. Regarding facts, we are bound by the finding given by the Appellate Tribunal. The Appellate Tribunal clearly held that there was an expansion programme and the assesses company incurred vast sums for setting apart the profits earned during the relevant years. The findings of the Tribunal in this regard are as follows :
'The assessee (company) had in fact taken steps for establishing a distillery unit in Shimoga. Up to the end of June, 1985, it had incurred a total expenditure of Rs. 52,08,892 for acquiring land and putting up the distillery plant including the preliminary expenses. This fact is evidenced by the certificate by the chartered accountants dated July 17, 1985. As per the fixed assets schedule as on June 30, 1986, the gross block was of the order of Rs. 3,70,79,789.38 and the capital work-in-progress including buildings and effluent treatment works constituted Rs. 51,62,483. If the assessee had not conserved such finance, it would have been very difficult for it to mobilise funds for the project which was in the offing and which had to be taken up in the very future. The factory had been set up and it has gone into production in June, 1986. Considering these facts, we are of the view that the potential need for financing the developmental project was a reasonable factor that weighed in the minds of the directors for not declaring dividends in these three years. This constitutes a valid defence to defend a proceeding under section 104(1).'
5. It was contended by the Revenue that the explanation of the assessee was not acceptable because the assessee failed to approach the Board under section 107A of the Act. It was contended that, in case the assessee requires the benefit of non-declaration of dividend or reduction in the dividend, the Act had provided machinery whereby, under section 107A of the Act, the assessee could approach the Board for appropriate relief. This was not accepted by the Appellate Tribunal resulting in the present references.
6. Sri Raghavendra Rao, learned counsel for the Revenue, strongly contended that the provisions of the sections 104, 105, 106, 107 and 107A of the Act are to be read together and these sections from part of a single scheme regarding additional income-tax on undistributed profits. Law specifically provides for a forum whereby an assessee can seek relief against distributing lower profits as dividends or the benefit of not declaring any dividend at all and the Board is empowered to grant section 107A, the Income-tax Officer cannot proceed with the order under section 104 till the Board decides the application filed by the assessee under section 107A of the Act. Further, it was pointed out that the assessee may also approach the Central Government under sub-section (8) of section 107A whereunder the Central Government may grant the requisite relief by appropriate notification.
7. Sri Ramabhadran, learned counsel for the assessee, raised the following contentions :
(1) In the case of a company which had not declared any dividend at all, the very language of section 107A is not attracted and, therefore, the assessee need not file any application to the Board. (2) Alternatively, under section 107A(2), option is given to the assessee to approach the Board or not to approach the Board. It is entirely at the discretion of the assessee to make an application or not to make an application. The assessee may choose to places an appropriate explanation and justify the non-declaration of dividend before the Income-tax Officer himself under section 104(2), because in such a case, the assessee would be having the benefit of an appeal files an application under section 107A, he would be denied the benefit of approaching the Appellate Tribunal and this court under reference, in view of sub-section (9) of section 107A of the Act.
8. The scope of section 104 is quite well-established. It is penal provision. The provision is to compel the company to declare dividends failing which the assessee could be penalised under section 104(1). The provision is similar to section 23A of the Indian Income-tax Act, 1922. The additional tax leviable under section 104(1) is on the percentage of distributable income as reduced by the amount of dividends actually distributed, if any. However, the levy of this additional tax is not automatic. Two conditions are required to be satisfied before the provision is attracted. The first condition is the finding regarding the distributable income and that the dividend declared by the assessee was less than the statutory percentage of the distributable income. Even in a case where there is a finding that the dividend declared by the assessee was less than the statutory percentage of the distributable income, still the Income-tax Officer shall not make an order levying additional tax if he is satisfied that, having regard to the losses incurred by the company in earlier years or to the smallness of the profits made in the previous year, the payment of a dividend or a larger dividend than that declared would be unreasonable. It is unnecessary to refer to sub-section (2) of section 104 of the Act here. It is mandatory that the Income-tax Officer will have to be satisfied as to whether, having regard to the smallness of the profits made in the previous year, payment of a higher dividend would be unreasonable. This investigation as to the reasonableness of the situation under which a particular dividend was declared by the company or the circumstances leading to non-declaration of any dividend. It has also been held by the Supreme Court that the profit referred to herein is commercial profit. The approach of the Income-tax Officer in this aspect has been explained in CIT v. Gangadhar Banerjee and Co. (Private) Ltd. : [1965]57ITR176(SC) . It was held therein that the provision of section 23A of the old Act (similar to the present section 104) is in the nature of a penal provision and, therefore, the Revenue has strictly to comply with the provisions therein. At page 181, the Supreme Court made the following observation :
'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 directors. 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 hand the reasonable requirements of the future and similar others. He must take an overall picture of the financial position of the business. It is neither possible nor advisable to lay down any decisive tests for the guidance of the Income-tax Officer. It 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.'
9. Thereafter, the Supreme Court also emphasised the term 'having regard to' found in the opening clause of sub-section (2) of section 104 of the Act (we have referred to the present section for the sake of convenience). At page 184, the nature of the provision was stated thus :
'Section 23A of the Act is in the nature of a penal provision. In the circumstances mentioned therein the entire undistributed portion of the assessable income of the company is deemed to be distributed as dividends. Therefore, the Revenue has strictly to comply with the conditions laid down thereunder. The burden, therefore, lies upon the Revenue to prove that the conditions laid down thereunder were satisfied before the order was made.'
10. The substance of section 104(2) involves a consideration as to the reasonableness of the conduct of the assessee in declaring a lower dividend or not declaring any dividend due to business consideration. If the assesses company decides to set apart a substantial part of its profits for its future expansion and, under the circumstances, it could be accepted as reasonable, the Income-tax Officer is expected to accept the explanation and will have necessarily to hold that the declaration of any dividend or a higher dividend would be unreasonable in the circumstances.
11. Sri Raghavendra Rao contends that section 107A of the Act specifically provides for such a situation and the assessee could have approached the Board.
Section 107A reads thus :
'Reduction of minimum distribution in certain cases. - (1) If any company to which the provisions of section 104 apply (not being an investment company) considers that, having regard to the current requirements for the development of its business, it would not be possible or advisable for it to declare or pay a dividend of an amount larger than that already declared or paid or proposed to be declared or paid by it, it may make an application to the Board for reduction of the amount of the minimum distribution required under this Chapter.
(2) Every application under sub-section (1) shall be in the prescribed form and shall be verified in the prescribed manner and shall be made within the period of twelve months referred to in sub-section (1) of section 104 or, where the Income-tax Officer has served on the company a notice under sub-section (1) of section 105 of his intention to make an order under section 104, within thirty days of the receipt of such notice.
(3) Every application under sub-section (1) shall be accompanied by a fee of one hundred rupees.
(4) If the Board is satisfied that a distribution equal to the statutory percentage of the distributable income of the company concerned would be unreasonable, it may reduce the amount of minimum distribution required of the company under this Chapter by such amount, not exceeding twenty per cent, of the statutory percentage of its distributable income, as it may consider fit and further determine the period within which such distribution shall be made.
(5) The Board shall not reject an application made under sub-section (1) without giving the company concerned an opportunity of being heard and its decision shall be final as respects matters concluded by it.
(6) Where an application is made by the company after receipt of a notice from the Income-tax Officer under sub-section (1) of section 105 and a further distribution is made in accordance with the decision thereon of the Board, such further distribution shall not be taken into account in deciding whether the provisions of section 104 apply in respect of the previous year in which the further distribution is made.
(7) Where an application is made by an company under this section, the Income-tax Officer shall not make any order under section 104 until the decision is given by the Board on that application :
Provided that where a company is required to make a distribution or further distribution of its profits and gains in accordance with the decision of the Board and fails to make such distribution or further distribution within the period determined thereunder, the Income-tax Officer shall make an order under section 104 as if no reduction of the amount of minimum distribution had been made by the Board under this section.
(8) If the Central Government is of the opinion that it is necessary or expedient in the public interest so to do, it may, by notification in the Official Gazette, declare that the provisions of this section shall not apply to any class of companies or in regard to the whole or any part of the profits and gains of any class of companies.
(9) Notwithstanding anything contained in section 246, no appeal shall lie to the Commissioner (Appeals) against an order of the Income-tax Officer under section 104 in a case where a decision has been given by the Board
(10) The Board may, by notification in the Official Gazette, direct that, subject to such conditions, if any, as may be specified in the notification, the powers exercisable by it under this section shall also be exercisable by any Commissioner in respect of such companies or classes of companies as may be specified therein and thereupon in respect of such companies or class of companies the provisions of this section and sections 106 and 107 shall have effect as if reference in the said sections to the Board were reference to such Commissioner.'
12. In a case where the assessee has to set apart certain profits to meet the requirements for the development of its business, it is contended before us by learned counsel that section 107A is directly attracted. We are of the view that section 107A is only a procedural provision. It gives an option to the assessee to approach the Board if the assessee considers it advantageous or necessary. In response to a notice under section 104(1), the assessee may participate in the proceedings before the Income-tax Officer or may approach the Board section 107A provided to the case of the assessee is that, having regard to the current requirement for the development of its business, it would not be advisable for the assessee to declare or to pay dividend of an amount larger than that already declared or paid. The section does not say that assessee 'shall' make an application to the Board. The language is prima facie directory because the word used is 'may' and not 'shall' in sub-section (1) of section 107A.
13. There is another reason as to why we should hold this provision directory. Sub-section (4) of section 107A has restricted the Board's power to grant relief to an assessee when approached under section 107A. The Board may reduce the amount of minimum distribution required of the company by such amount not exceeding twenty per cent. of the statutory percentage of its distributable income.
14. As observed by the learned authors, Kanga and Palkivala in their 'Income-Tax Act' (8th edition at page 1025), this provision provides for only chance of getting the meagre relief of having a minimum distribution reduced by 1/5th. In a case where the assessee genuinely required the entire profits to be set apart and no dividend could be reasonably declared, the Board would be helpless in granting the relief to the assessee. The very purpose of sub-section (2) of section 104 will be defeated in such a situation. It is no answer to the problem to point out that the assessee may approach the Central Government under section 107A of the Act.
15. In View we have taken as above, it is not necessary for us to consider the first aspect of the contention urged by Sri Ramabhadran that section 107 is not attracted at all in the case of a company which has not declared any dividend.
16. For the reasons stated above, the question referred we will have to necessarily answered in the affirmative and against the Revenue.
17. Reference answered accordingly.