West Coast Paper Mills Ltd. Vs. Commissioner of Income-tax Bombay - Court Judgment

V.S. Desai, J.

1. The question raised on this reference arises out of an order made against the assessee treating it to be under default under section 18 (7) of the Indian Income-tax Act, in respect of the taxes that should have been deducted and paid but not paid by it. The assessee is a public limited company incorporated on the 25th March, 1955. Part of its paid up capital consists of 60,000 6% (free of tax) cumulative preference shares of Rs. 100 each. The company's year of account ended on the 30th of June of each calendar year and in the first three years of its existence, viz., in the years ended on 30th June, 1956, 30th June, 1957, and 30th June, 1958, the company did not make any profits out of which it could distribute dividends and, therefore, no dividend was declared on the preference shares with reference to those three years. In the next year thereafter, which was the year ended on the 30th June, 1960, the company made profits. During the course of this year, on 9th February, 1960, the board of directors of the company passed a resolution 'that the dividend on the 60,000 cumulative preference shares of the company of Rs. 100 each in respect of the years ended 30th June, 1956, and 1957, remaining in arrears be paid at the rate of 6% free of tax out of the profits of the current year ending on 30th June, 1960.' On 30th May, 1960, they passed a similar resolution for the payment of dividend on the cumulative preference shares which had remained in arrears in respect of the third year ended 30th June, 1958. In accordance with these resolutions, the dividends were actually paid from 25th April, 1960, and 24th June, 1960, respectively. Adjustments with reference to these dividends were made in the balance-sheet prepared as at 30th June, 1960, and in the said balance-sheet a sum of Rs. 7,56,000 was shown as preference share dividend for the three years ended 30th June, 1958. At the annual general meeting of the company, which was held on 28th March, 1961, the payments of the dividends on the cumulative preference shares in accordance with the resolutions passed by the board of directors were confirmed by the said annual general meeting and dividends on preference shares for the subsequent years, viz., 1958-59 and 1959-60, as proposed by the board of directors were also passed. Now, by the Finance Act of 1959, certain changes were introduced in the scheme of taxation of the company and of the shareholders. By section 9 of the said Act, which introduced an amendment in section 18 (3D) of the Indian Income-tax Act and also introduced a further sub-section as and (3E), an obligation was imposed upon the company to deduct tax on dividends declared by the company and remit it to the Government. By section 19(2) of the Finance Act, the provisions introduced by section 18(3D) and 3(E) were brought into force with effect from April 1, 1959. Sub-section (4) of section 19 of the Finance Act, however provided an exemption from the operation of the provisions of section 18 (3D) and (3E) in certain circumstances. The extent of the exemption permitted under this sub-section was modified with retrospective effect by the Finance Act of 1960. The provisions of section 19 (4) as amended subsequently with retrospective effect was as follows :

'Notwithstanding anything contained in sub-section (2).... in relation to the dividends declared or payable by a company on or before the 30th day of June, 1960, in respect of any previous year relevant to any assessment year prior to the assessment year 1960-61, the Income-tax Act shall have effect as if the amendment contained in....... section 9 .... had not been made'.

2. The company did not deduct the taxes from the dividends declared on February 9, 1960, and May 30, 1960, and paid out subsequently in April and June, 1960, because in its opinion they were entitled to exemption from the operation of section 18 (3D) and (3E) by reason of section 19 (4) of the Finance Act. In the course of the assessment of the company for the assessment year 1960-61, the Income-tax Officer took the view that the company ought to have deducted the tax in respect of the said dividends, as they were not entitled to the exemption contained in section 19 (4) of the Finance Act. In his opinion, therefore, the company was liable to be treated as having committed a default under section 18 (7) of the Income-tax Act. He, therefore, called upon the company to show cause why action under section 18 (7) should not be taken against it and ultimately made an order under the said section to the extent of Rs. 2,32,748.70. According to the Income-tax Officer, since the dividends were declared out of the profits of the previous year ended 30th June, 1960, they were in the nature of interim dividends pertaining to the previous year relevant to the assessment year 1961-62 and, consequently, not entitled to exemption under section 19 (4) of the Finance Act, which gave that exemption in relation to dividends declared in respect of any previous year, relevant to any assessment year prior to the assessment year prior to the assessment year 1960-61. The view taken by the Income-tax Officer was confirmed in appeal by the Appellate Assistant Commissioner, who observed that, as the dividend had been declared out of the income of the year for which the relevant assessment year was the year 1961-62, provisions of section 19 (4) of the Finance Act were clearly inapplicable to the said dividends. In the further appeal to the Income-tax Appellate Tribunal, it was contended on behalf of the assessee that the view taken by the Income-tax Officer and the Appellate Assistant Commissioner that, because the dividends were paid out of the profits of the previous year 1959-60, relevant to the assessment year 1961-62, the exemption under section 19 (4) of the Finance Act was not available, was clearly wrong. It was argued that the dividends, which the company had declared on 9th February, 1960, and on 30th May, 1960, were in respect of the three years ended the 30th June, 1956, 30th June, 1957, and 30th June, 1958, for which the dividend to which the preference shares were entitled in respect of the said three years. The dividend for the previous year 1959-60 on the preference shares was declared at the annual general meeting but the earlier dividends, which were declared on 9th February, 1960, and on 30th May, 1960, were not in respect of the year 1959-60 but in respect of the earlier years. It was argued on behalf of the assessee that section 19 (4) of the Finance Act was enacted to give exemptions in respect of such dividends which were in respect of the earlier years and which were declared between the dates 1st April, 1959, when the new obligation of deducting tax source was imposed on the company, and the 30th June, 1960.

3. The Tribunal did not accept this contention, which was put forth by the assessee. Relying on two English decisions, one in In re Wakley and the other in Godfrey Phillips Ltd. v. Investment Trust Corporation Ltd., it took the view that dividends on cumulative preference shares, which are in arrears, when subsequently paid, do not constitute dividends in respect of the years in which they are declared. In that view of the matter, the Tribunal was of the opinion that the dividends declared by the company on February 9, 1960, and May 30, 1960, were dividends in respect of the year 1959-60 and consequently in respect of the previous year relevant to the assessment year 1961-62. The dividends, therefore, were not entitled to exemption under section 19 (4) of the Finance Act, 1959, and the company was under an obligation to deduct taxes on the said dividends and pay it over to the Government. According to the Tribunal, therefore, the Income-tax Officer was right in making an order under section 18 (7) of the Indian Income-tax Act against the company. The assessee applied under section 66 (1) of the Income-tax Act for a reference to this court and on the said application the Tribunal has referred the following question to this court as arising out of its order :

'Whether in view of section 19 (4) of the Finance Act, 1959 (as amended by the Finance Act, 1960), there was any obligation to deduct tax under sections 18 (3D) and (3E) from the dividends declared on February 9, 1960, and May 30, 1960, so as to justify the order under section 18 (7) of the Income-tax Act, 1922, on failure to do so ?'

4. Sections 18 (3D) and (3E), which were introduced by the Finance Act, 1959, so far as they are material for our purpose, run as follows :

'18. (3D) The principal officer of an Indian company or a company which has made the prescribed arrangements for the declaration and payment of dividends within India shall, before making any payment in cash, or before issuing any cheque or warrant in respect of any divined or before making any distribution or payment to a shareholder of any dividend within the meaning of sub-clause (a) or sub-clause (b) or sub-clause (c) or sub-clause (d) or sub-clause (e) of clause (6A) of section 2, deduct on the amount of such dividend, income-tax and super-tax at the prescribed rates :.....

(3E) Where any share held by a shareholder carried as respects dividend a preferential right to be paid a fixed amount or an amount calculated at fixed rate free of tax, then, notwithstanding such preferential right, tax shall be deductible under sub-section (3D), and for the purposes of such deduction the amount as would, after deduction of a sum equal to thirty per cent, thereof, be equal to the net amount of dividend receivable by the shareholder free of tax'.

5. It would thus be seen that under sub-section (3D) an obligation is imposed upon the company to deduct income-tax and super-tax at the prescribed rate on the amount of the dividends or other payments which fall in the extensive definition of the word 'dividend' as defined in clause (6A) of section 2 of the Indian Income-tax Act before payment of the dividends is made to the shareholder. Sub-section (3E) is a further provision relating to the deduction of tax in respect of the preference shares carrying a right to a dividends at a fixed rate free of tax. By sub-section (2) of section 19 of the Finance Act, 1959, the amendments introduced by sections 18 (3D) and 18 (3E) are made applicable from the 1st day of April, 1959. It would, therefore, follow that as from that date there would be an obligation on the company to deduct taxes on the amounts of dividends declared and made payable by it to the shareholders. The legislature, however, has provided for the exemption from this obligation in cases specified in section 19 (4) of the Finance Act, 1959. The provisions of this sub-section have already been reproduced by us earlier and it will be clear from the said provisions that the cases to which the said provisions will apply must satisfy two conditions : the first is that, the dividends must be declared or be payable by the company on or before the 30th day of June, 1960, since after the application of the new provisions introduced by the Finance Act, i.e., they must be declared or be payable between the dates April 1, 1959, and June 30, 1960, and the second is that, dividends which are declared or made payable during the interval must be in respect of any previous year relevant to any assessment year prior to the assessment year 1960-61. Now, the previous year relevant to the assessment year 1960-61 would be a year ending on or before March 31, 1960. Consequently, the previous year relevant to any assessment year prior to the assessment year 1960-61 would be the previous year ending on the 31st March, 1959 or an earlier previous year. In order to qualify for the exemption under section 19 (4) of the Finance Act, therefore, the dividend declared or payable by the company between the dates April 1, 1959, and June 30, 1960, must be in respect of a previous year ending on the 31st March, 1959, or an earlier previous year. There is no doubt in the present case that the first of the two conditions specified in section 19 (4) of the Finance Act, 1959, is clearly satisfied. The only question is whether the second condition is also satisfied, and that would depend upon whether the dividends declared by the company on February 9, 1960, and on May 30, 1960, and paid out by it on April 25, 1960, and June 24, 1960, are dividends 'in respect of the previous year relevant to the assessment years, which are prior to the assessment year 1960-61' within the meaning of the provision. Now, if the resolutions of the company could determine the matter, the said resolutions in terms refer to the declared dividends as in respect of the years ended on the 30th June, 1956, 30th June, 1957, and 30th June 1958. The annual report and accounts of the company for the year ended 30th June, 1960, would also show that in the notice of the annual general meeting setting out the agenda for the meeting the dividends were referred to as the dividends paid on the preference shares for the accounting years 1956, 1957, 1958 and 1959. In the directors' report, the dividends paid ar also referred to as for the years ended 30th June, 1956, 30th June, 1957, and 30th June, 1958, respectively, and in the profit and loss account also a sum of Rs. 7,56,000 has been shown as preference share dividends for the aforesaid three years, ended 30th June, 1958. It is said, however, that the resolutions of the directors declaring the dividends as in respect of certain years will not make the said dividends in respect of the said years, unless in law they could be treated as dividends of the said years. It was argued that in law the dividends which were declared and paid by the company in its year of account 1959-60 could only be dividends in respect of the said year of account and not in respect of any earlier year in which the preferential dividends to which the preference shareholders were entitled, were not paid. Although the quantum of dividend paid in the year of account may have been determined with reference to or after taking into account the dividend unpaid in earlier years, that does not make any part of the dividend paid as in respect of the earlier years but the whole of the dividend paid is the dividend paid in respect of the year of account. The argument advanced in this connection is as follows : A shareholder of a company has a right to participate in the division of the profits of the company. A preference shareholder has a preferential right to be paid out of the profits of the company when the said profits are distributed at a fixed rate. A cumulative preference shareholder is entitled to receive a dividend at a fixed rate every year and if in any year there are no profits and no dividends paid to him, he is entitled to have the same paid out to him in later years when there are profits out of which the payments could be made. The right of a shareholder to the dividend, however, is a contingent right and becomes an enforceable right on the contingencies having occurred, viz., that the company has made profits and has further determined to distribute the same. In other words, the right of a shareholder to the dividend is a right dependent upon the availability of profits and the determination of the company to distribute the same. In the case of a cumulative preference shareholder, therefore, although the shareholder is entitled to a dividend at a fixed rate for every year, the right again is subject to the same conditions, viz., that there must be profits made by the company and that there must be a determination to distribute the same. When, however, the company has profits and decides to distribute them, it would be obligatory on the part of the company to pay the cumulative preference shareholder not only the dividend at the fixed rate to which he is entitled in the year of distribution but, it he has not been paid in earlier years, to the payments which have remained in areas. The payments, however, which were not made in the earlier years, could not be treated as arrears in the sense that they were due and payable but were passed over by the company, because the dividends would not be due and payable unless there are profits available for distribution and the company has decided to distribute the same. It is, therefore, argued that that being the position in law, the dividend when declared would not constitute a dividend in respect of earlier years but a dividend in respect of they year of declaration, although the measure of the dividend declared may be with reference to the undischarged liabilities in respect of the previous years. Support for this argument was sought to be derived from two English cases in In re Wakley and Godfrey Phillips Ltd. v. Investment Trust Corporation Ltd. The facts of the first case briefly stated were : that a testator had specifically bequeathed cumulative preference shares in a company to his son, R, and settled his residuary estate upon trust for all his children, He died in 1905 and his son, R, got the cumulative preference shares, which were bequeathed to him. Dividend on the said cumulative preference shares had not been paid for the years 1904 to 1907. In 1907, however, dividends were declared on the said preference shares and the question arose as to whether R was entitled to the whole of the amount or a portion thereof appropriate to the period prior to the death of the testator would go to swell his estate, and not go to R in view of the provisions of the Apportionment Act, which had enacted that dividends like interest on money lent be considered as accruing from day to day and shall be apportionable in respect of time accordingly. It was decided in that case that, having regard to the nature of the right to dividend until profits or other moneys of the company were available for dividend and it had determined to distribute the same. It is only on the fulfillment of these conditions that a right to dividend could be said to have been acquired by, or accrued to, the shareholder and since in the case in question, the acquisition or the accrual was in the year 1907, when the company had profits and it had determined to declare a dividend, it was R, the son, who was entitle to the same. It was in this context that it was held that dividend on cumulative preference shares, which are in arrears, when paid, is not paid in respect of each year but in respect of the year in which there profits are declared for distribution, although the amount is determined on the basis of the whole amount of the dividend unpaid. In the other case, the dividend paid by the company on cumulative preference shares for a number of years since 1939, was found to be deficient on challenge made to the method of computation of the dividend adopted by the company and the company decided to make up the deficient payment, and a question arose as to whether the aggregate amount should be distributed among the holders of those shares registered at the respective times when the deficient dividends were paid or should be paid wholly to those registered at the time of payment. It was held that the distribution would take the form of a dividend and, would be solely in respect of the year in which it was declared and consequently, persons entitled to the division would be those on the share register at the date of the declaration.

6. It is no doubt true that, in both these cases, the view was taken that the dividend declared by a company would be in respect of the year in which it is declared and that will be so, even if the quantum of the dividend declared is determined with reference to the amount of dividend unpaid in case of cumulative preference shares, which carried a right to be paid at a fixed rate per year. The question, however, to be considered is whether the language used in section 19 (4) of the Finance Act, 1959, takes into account this legal position or does it use the expression 'in respect of any previous year' in a different meaning. It may be pointed out straightaway that there can be no doubt whatsoever that section 19 (4) contemplates cases where dividends could be declared or made payable by a company in respect of a year earlier than the year in which the declaration is made. The interval during which the declarations or payments to which section 19 (4) may apply is between the dates April 1, 1959, and June 30, 1960. It is contemplated by this section that by resolutions of the company passed during this interval it would be possible to declare dividends in respect of years prior to the previous year relevant to the assessment year 1960-61. The last of these prior years contemplated by this provision would be the year ending on or before the 31st March, 1959. It would, therefore, be clear that this section contemplates the possibilities of dividends being declared by the company subsequent to the 1st of April, 1959, and before the 30th June, 1960, in respect of the years prior to 1st April, 1959. If the principle is accepted that the dividend when declared is in respect of the year in which the dividend is declared, it would appear that a dividend declared subsequent to the 1st of April, 1959, could not be a dividend in respect of an earlier year and the provisions of section 19 (4) of the Finance Act would be rendered nugatory.

7. Mr. Joshi, the learned counsel for the revenue, has pointed out that cases can be conceived of where declaration with regard to the dividends in respect of years prior to the 1st April, 1959, could be made subsequent to 1st of April, 1959, as for instance, in cases where the annual general meetings of the said earlier years have been held subsequent to 1st April, 1959. We do not see, however, any indication in the said provision, which would show that it was intended to cover such cases only. It is no doubt true that the dividend declared in a later year, after having taken into account the unpaid arrears of the prior years, would still be a dividend in respect of the year in which it is declared in the sense that the right to the dividend would accrue and be acquired by the shareholder in that year and it could not be said to have accrued to him or acquired by him in respect of each of the years of arrears. Nevertheless, the dividend paid in the subsequent year could still be regarded as paid with reference to all the years of arrears, inasmuch as the quantum paid is on the basis of the arrears for all the years. The expression 'in respect of any previous year' in our opinion is quite capable of being interpreted as with reference to any previous year and it is possible to give the provision a construction that what it has intended is that, where dividends are declared within the dates specified, viz., 1st April, 1959, and 30th June, 1960, if the dividend declared has reference to the claim for dividends for any prior year, which is prior to the previous year relevant to the assessment year 1960-61, the obligation imposed on the company to deduct the taxes will not apply to that extent. The reason why we are inclined to take this view is that, in our opinion, the legislature having decided to impose an obligation on the company to deduct tax on dividends paid after April 1, 1959, has by the provisions of section 19 (4) made the said obligation to apply to their right to receive the same in respect of the previous year relevant to the assessment year 1960-61 and thereafter and not in respect of the prior years.

8. Mr. Joshi, learned counsel for the revenue, has pressed upon us that in interpreting the said provision, we should give the language 'dividend declared in respect of any previous year' the meaning which it should have, having regard to the concept of dividend under the Companies Act and the meaning that the said expression has in company law matters. He has invited our attention to a passage from the Handbook on the Formation, Management and Winding Up of Joint Stock Companies by Sir Francis G. Brown, at page 522, where the learned author has stated as follows :

'Under articles of association in the ordinary form, failure to pay a dividend in any year upon shares entitled to a cumulative preferential dividend does not constitute a debt for the amount of such dividend. Therefore, if in some subsequent year or financial period a dividend is declared which is sufficient to make up the arrears, this dividend is not a dividend in respect of the year, or years, during which no payment was made. Its amount may be measured by the arrears, but it is a divided for the year, or other financial period, in which it was declared'.

9. He has referred us to Buckley on the Companies Act (13th Edn.) at pages 895 and 896, where it has been observed as follows :

'The declaration of a dividend creates a debt due from the company to each shareholder and payable at the date at which the dividend is made payable....... 'Arrears of dividend' and 'back dividends' are inaccurate expressions'.

10. Mr. Joshi has then referred us to Palmer's Company Law Precedent, 17th edition, at page 775, where it is stated :

'The terms 'cumulative preferential dividend' means a dividend payable out of the profits generally in priority to the subordinate class or classes of shares so that if the profits of one year are not sufficient to pay the dividend for that year, the deficiency accumulates as against subsequent profits, and has to be cleared off before any dividend can be paid on the sub-ordinate class or classes'.

11. Further, Mr. Joshi his invited our attention to a passage from Halsburys, 3rd edition, volume 6, at para. 778, on page 402 of the said volume, where it has been stated as follows :

'A final dividend can, as a general rule, only be sanctioned at the annual meeting, when the accounts are presented to it, and the articles usually contain specific provision to this effect. A power to declare interim dividends is usually vested by the articles in the directors. An interim dividend is a dividend declared at some date between the ordinary general meetings'.

12. According to the learned counsel, the directors of a company have no authority to declare a dividend in respect of a year, the annual general meeting in connection whereof has already taken place and the accounts closed in subsequent years, and has in that connection invited our attention to a decision of the Calcutta High Court in Raghunandan Neotia v. Swedeshi Cloth Dealers Ltd., in which it has been held as follows :

'Where the accounts were closed at the annual general meeting, dividends cannot be declared retrospectively and with reference to the years accounts whereof were closed even if the directors remain the same'.

13. In view of these principles, the learned counsel has argued that the dividends declared by the directors on 9th February, 1960, and 30th May, 1960, are dividends in respect of the account year 1959-60, relevant to the assessment year 1961-62, and, consequently, not exempted under section 19 (4) of the Finance Act.

14. We have no hesitation in agreeing with him as to the principles of the company law, which he has mentioned to us in his argument, and we also agree with him that the said dividends declared on the 9th February, 1960, and the 30th May, 1960, are in respect of the account year 1959-60, in the sense that the right to be paid the amount of such dividends has accrued to, and has been acquired by, the shareholders in the account year 1959-60, and the said amount has become a debt due and payable by the company only in that year of account. There can, however, be no doubt, in our opinion, that, although the right to receive the payment has accrued in the year 1959-60, the payment to be received was in respect of what the shareholder was entitled to receive in respect of the prior years and, in that sense, to the arrears of the prior years. Although, therefore, the payment declared was a payment of the dividend of the year of declaration, it was still referable to a payment with reference to the prior years. In our view, the language used in section 19 (4) applies to such payments and the expression 'in respect of any previous year prior to....' as used in section 19 (4) of the Finance Act, is wide enough to include payments referable to the undischarged liabilities in respect of the said years. If the said liability had been discharged in the said prior years by payments made in respect of those years as understood in the company law, they would not have been affected by the amendments introduced in the Income-tax Act by the Finance Act of 1959. The legislature, in our opinion, has intended that the said payment should be exempted even after the introduction of the amendment and the mere circumstance that the payment made is in a later year should not result in the deprivation of that exemption. In our opinion, therefore, the departmental authorities and the Tribunal were in error in holding that there was an obligation on the company to deduct tax under section 18 (3D) and (3E) from the dividends declared on February 9, 1960, and May 30, 1960, so as to justify the order under section 18 (7) of the Indian Income-tax Act, 1922, on failure to do so.

15. The result, therefore, is that the question referred to us is answered in the negative. The assessee will get its costs from the department.

16. Question answered in the negative.