1. The first item is with regard to the addition of Rs. 1,55,985 under Section 2(22)(e) by way of deemed dividend. The Income-tax Officer made an addition of Rs. 3,83,930. While working out the accumulated profits the Income-tax Officer has, among other items, included items such as research & development expenditure on building, plant and machinery of Rs. 2,95,360.
2. On appeal, the CIT (Appeals) held that the Income-tax Officer was right in including the sum of Rs. 2,95,360 for the purpose of working out the accumulated profits. However, the assessee is entitled for deduction in respect of depreciation on the sum of Rs. 2,95,000. Thus, he confirmed the computation of the accumulated profits at Rs. 1,55,985.
3. The learned counsel for the assessee did not contest the item of Rs. 82,000 relating to the building in research & development division.
But, he strongly urged that the plant and machinery of the value of Rs. 2,12,360 installed in the research & development division was absolutely necessary in order to keep with the latest technology and the said amount has been allowed as deduction under Section 35. This is an outgoing which is not available with the assessee. This cannot be included while working out the accumulated profits. He urged that the commercial profits alone is to be taken and while doing so the outgoings cannot be included in the accumulated profits. The learned departmental representative submitted that the amounts spent for plant and machinery is a capital expenditure and it is not allowable as a deduction. It is rightly included while working out the accumulated profits.
4. We have considered the submissions. The expression 'accumulated profits' occurring in Clause (e) of Sub-section (22) of Section 2 means profits in the commercial sense. In P.K. Badiani v. CIT [1976] 105 ITR 642 (SC) while considering Clause (e) of Section 2(6.A) of the Indian Income-tax Act, 1922 which is similar to Section 2(22)(e) of the Income-tax Act, 1961 the Supreme Court held that accumulated profits means profits in the commercial sense and not assessable or taxable profits liable to tax as income. In CIT v. Gangadhar Banerjee & Co.
(P.) Ltd. [1965] 57 ITR 176, the Supreme Court held that the words 'smallness of profit' in Section 23A of the Indian Income-tax Act, 1922 refer to actual accounting profits and not the assessable profits of the year. At page 181, it was observed as follows : What does the expression 'profit' mean Does it mean only the assessable income or does it mean commercial or accounting profits If the scope of the section is properly appreciated the answer to the said question would be apparent. 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 and 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 arise in each case.
In CIT v. Bipinchandra Maganlal & Co. Ltd. [1961] 41 ITR 290, the Supreme Court held that the 'smallness of profits' in Section 23A of the Indian Income-tax Act, 1922 has to be adjudged in the light of commercial principles and not in the light of total receipts, actual or fictional. In Rajpal Bros. (P.) Ltd. v. CIT [1971] 80 ITR 463, the Bombay High Court while considering the expression "accumulated profits" in Section 2(6A)(e) of the Indian Income-tax Act, 1922 held that the phrase "accumulated profits" does not mean the aggregate of the assessed income arrived at after disallowing disbursements and expenditure in fact incurred. At page 466, it was observed as under: It is clear on the plain language of the above section that loans advanced to shareholders can be held to be dividend only if an assessee-company is found to be in possession of accumulated profits at the relevant dates. Apparently, the commercial profits accumulated by the concerned assessee-company cannot be ascertained and/or calculated without reckoning or taking into account all and singular the disbursements made and expenditure in fact incurred.
The intent and purpose of the section appears to be to prevent disbursements to shareholders of the profits made by a company by way of loans and not by way of dividends. It is difficult to hold that the phrase 'accumulated profits' in this section refers to the aggregate of the assessed income arrived at by disallowing disbursements and expenditures in fact incurred. There was no justification for the tax authorities and the Appellate Tribunal to proceed to arrive at the accumulated profits of the assessee-company by merely totalling up the income of the assessee-company as assessed by previous assessment orders. That the profits and/or income mentioned in these orders will not reflect the profits accumulated and in fact in the hands of the assessee-company is patent. This can be illustrated by referring to the fact of the disbursements and expenditure in fact incurred by the assessee-company for payment of salaries to the two directors in the amounts which we have already referred to above. It is true that bogus accounts and/or bogus debit entries can be found out and will not represent actual expenditure and/or disbursement. Such fraudulent debits would not form part of the true expenditure of the company and will accordingly continue in the hands of an assessee as part of the accumulated profits. This, however, does not mean that what is in fact expended and disbursed can be held to be possessed and to continue in the hands of the assessee-company and can form part of the 'accumulated profits'.
In our view, the ratio laid down in the above case would squarely apply in the instant case. The sum of Rs. 2,12,360 incurred as expenditure for the plant and machinery installed in the research division is an outgoing and it cannot be included in the 'accumulated profits'. No doubt, the said expenditure is a capital expenditure. While considering the expression 'accumulated profits' what is to be taken into account is the commercial profits. While deciding the commercial profits, the outgoings have to be taken into consideration as held by the Supreme Court in Gangadhar Banerjee & Co. (P.) Ltd.'s case (supra). It was held therein that the overall picture of the financial position of the business has to be taken into account and the Income-tax Officer will have to put himself in the position of a prudent businessman or director and consider the matter with an objective approach. In the instant case, the installation of the plant and machinery in the research division is very essential to keep up with the latest technology and survive in the business in competition with others.
Thus, the outgoing to the extent of Rs. 2,12,360 for the plant and machinery cannot be included in the accumulated profits. It is the profit possessed excluding the outgoings which could be considered in determining the accumulated profits.
5. The learned departmental representative relied on the decision of the Supreme Court in the case of P.K. Badiani (supra). There the issue was whether the development rebate reserve created by charging the amount to profit & loss a/c would constitute accumulated profits. The Supreme Court held that although the development rebate or initial depreciation does not form part of the assessable profits, undoubtedly it does form part of the commercial profits. In our view, the above decision is distinguishable. It may be seen that the initial depreciation or development rebate was allowed by way of incentives for installation of new machinery or plant. It was not an outgoing. The amount was available with the assessee. Thus, the above decision is not applicable to the facts of the instant case. In the instant case, the sum of Rs. 2,12,360 in respect of plant and machinery is an outgoing and it cannot be included in the 'accumulated profits'. We exclude Rs. 2,12,360 from accumulated profits. Thus, we delete the addition of Rs. 1,55,981.
6. The next item is against the addition of Rs. 2,15,343 towards hundi loan sustained by the Commissioner (Appeals). The Income- tax Officer noticed that the assessee borrowed on hundies and the receipts and the payments were not by means of account payee cheques as required Under Section 69D. The hundi loans borrowed in cash were to the extent of Rs. 3,29,500 and repayment of hundi loan in cash to the extent of Rs. 65,500 and interest payments to the extent of Rs. 18,843, thus totalling to Rs. 4,13,823. The Income- tax Officer did not accept the assessee's contention that the documents in the form of promissory notes are not hundies. The assessee contended that the borrowals and repayments were genuine and some of the loans were mere renewals.
Hence, no disallowance should be made under Section 69D. The Income-tax Officer did not accept this submission. The Income-tax Officer made an addition of Rs. 4,13,813.
7. On appeal, the CIT (Appeals) held that the Legislature has specifically intended that hundi borrowals should only be by crossed account payee cheques. All the borrowals which are effected through the medium of hundi irrespective of character of document (whether it is a promissory note or Bills of Exchange), are covered by Section 69D. He rejected the contention that the promissory notes are not covered by Section 69D even if they are in hundi form. He also rejected the contention that the hundies drawn in English are not hundies at all. On going through the hundi documents he found that the assessee had made two signatures, one as the drawee and another as an acceptor. While the former is in the capacity of the assessee (Sri M.B.S. Purushotham) whereas the second signature is in the capacity of proprietor of the firm. He held that it is not correct to state that the drawee and the acceptor were the same, as the two signatures were made in two different capacities. He found that the sum of Rs. 30,500 is to be considered in the assessment year 1980-81 and it cannot be added in this year. He also held that the various boruowals renewed from time to time cannot be treated as fresh borrowals. Thus, he held that the hundi borrowals of Rs. 1,68,000 which are clearly renewals of earlier hundies should be excluded from the addition. Thus, he upheld the addition of Rs. 2,15,343.
8. The learned counsel for the assessee strongly urged that the hundies are in English and they are in the nature of pronotes. The borrowals and repayments are genuine and the confirmatory letters have been filed. The addition made under Section 69D is not justified. He referred to few orders of the Tribunal where on identical facts the additions made under Section 69D was deleted. He submitted that those orders should be followed. The learned departmental representative strongly relied on the order of the Commissioner (Appeals). He submitted that once receipt or repayment of hundi amount is in cash Section 69D applies. Even if the hundi is in English it is only a hundi. He justified the disallowance.
9. We have considered the rival submissions. The assessee has filed confirmatory letters with the IT file numbers of the parties in respect of the hundi transactions. Their identity and genuineness is not doubted. The documents are in English and they are similar to the other documents which the Tribunal has considered in some cases. The Tribunal in its order in Instruments Techniques (P.) Ltd. [IT Appeal No. 246 (Hyd.) of 1984, dated 20-9-1984] and another order dated 6-8-1986 in IT Appeal Nos. 146 & 147/Hyd/86 held that once their identity and genuineness is not doubted and the document is in English, no disallowance can be made under Section 69D. We find that the documents in the assessee's case are similar to the documents in the above cases.
The reasoning given therein would equally apply to the instant case. We follow the above orders of the Tribunal. In the instant case, the confirmatory letters of the parties with their income-tax file numbers have been furnished. The identity and the genuineness of the transactions is not doubted. The documents are in English. They cannot be called as hundi documents. Hence, they are not hit by Section 69D.Following the above Tribunal orders, we hold that the addition of Rs. 2,15,343 cannot be sustained. Accordingly, we delete the same.
10. Other grounds raised in the appeal are not pressed and they are rejected.