Income-tax---

----Dividend---Deemed dividend---Loan to shareholder to the extent to which company possesses accumulated profits---Provision applies to a company which receives a loan from its wholly owned subsidiary---Loan received during accounting year should alone be taken into account---Reserve for development rebate forms part of "accumulated profits"---Indian Income Tax Act, 1961, S.2(22)(e). .

Explanation I to section 2(22) of the Indian Income Tax Act, 1961, clearly provides what is excluded from the ambit of the expression "accumulated profits". It excludes only capital gains arising over a certain period of time. The position is further clarified by Explanation 2 which says that the expression "accumulated profits" in sub-clauses (a), (b), (d) and (e) of section 2(22) shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses. The term "profits" means profits in the commercial sense. Development rebate reserves created out of the company's profits constitute a part of the accumulated profits of the company for purposes of section 2(22).

Badiani (P.K.) v. CIT (1976) 105 ITR 642 (SC) fol.

In view of the definition of "person" in section 2(31) which includes a company and the definition of "a person who has a substantial interest in the company" in section 2(32), section 2(22)(e) applies to a holding company and a wholly owned subsidiary company.

Sadhana Textile Mills Pvt. Ltd. v. CIT (1991) 188 ITR 318 (Bom.) fol.

Under section 8(a) of the Income Tax Act, 1961, for the purposes of inclusion in the total income of an assessee, any dividend declared by a company or distributed or paid by it 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 (22) of section 2 shall be deemed to be the income of the previous year in which it is so declared, distributed or paid, as the case may be. Therefore, only the payment received by the shareholder during the relevant previous year has to be taken into account and included as dividend by virtue of section 2(22)(e).

The assessee had obtained a loan from N Co. which was a 100 percent. subsidiary of the assessee. For the assessment year 1971-72, the Income Tax Officer brought to charge in the hands of the assessee company a sum of Rs.10,79,014 as deemed dividend under section 2(22)(e). He held that out of the total amount of loan taken by the assessee company from its subsidiary company, a sum of Rs.10,79,014 being the accumulated profits in the hands of the subsidiary company had to be regarded as dividend in the hands of the assessee-company and was assessable to tax accordingly in that assessment year. The Tribunal held that only the loan received by the assessee during the assessment year 1971-72 should be taken into account for the purposes of section 2(22)(e). Accordingly, it recalculated the deemed income of the assessee under section 2(22)(e) for the assessment year 1971-72, as Rs.2,83,346 and included the same in the income of the assessee for the assessment year 1971-72. On a reference:

Held, (i) that section 2(22)(e) applied to the assessee company though it held all the shares in the subsidiary company;

(ii) that the appropriations made to the development rebate reserve account in the. accounts of the subsidiary company up to March 31, 1970, were accumulated profits of the said company for the purpose of determining the amount of dividend under section 2(22)(e) in the hands of the assessee;

(iii) that the amount to be taken into account for the purposes of section 2(22)(e) for inclusion as dividend income of the assessee was the amount received by the assessee-company as a loan of the kind set out in section 2(22)(e) in the assessment year 1971-72. Hence the sum of Rs.2,83,346 was includible in the assessment of the assessee for 1971-72 under section 2(22)(e).

Dilip Dwarkadas, instructed by M/s. Gagrat & Co. for the Assessee.

G.S. Jetley and P.S. Jetley instructed by Mrs. S. Sengupta for the Commissioner.

JUDGMENT

SMT. SUJATA MANOHAR, J.---The assessee company is a private company carrying on the business of manufacturing chemicals. The reference pertains to the assessment year 1971-72. The relevant previous year was from July 1, 1969, to June 30, 1970. The assessee-company holds 100 percent. of the share capital of another private limited company known as Nestler Boilers Pvt. Ltd. Nestler Boilers Pvt. Ltd. has issued 775 shares of the face value of Rs.1,000 each. The assessee-company held at the material time 772 shares of the said company. It also held the remaining three shares of the said company in the name of other persons who were the nominees of the assessee-company. Hence, Nestler Boilers Pvt. Ltd. was a 100 per cent subsidiary of the assessee ?company.

The assessee-company had borrowed loans from its subsidiary company as follows:---

?

?

Thus, in the assessment year 1971-72, the assessee-company had taken loans from its subsidiary company. The accumulated total of such loans with interest was Rs. 25,49,856. .

The assessee-company filed its return of income for the assessment in 1971-72 showing a loss of Rs.13.53 lakhs. The Income Tax Officer, however, by his assessment order purported to bring to charge in the hands of the assessee? company a sum of Rs.10,79,014 as deemed dividend under section 2(22)(e) of the Income Tax Act, 1961. He held that out of the total amount of loan taken by the assessee-company from its subsidiary company, a sum of Rs. 10,79,014 being the accumulated profits in the hands of the subsidiary company had to be regarded as dividend in the hands a the assessee-company and was assessable to tax accordingly in that assessment year.

The Income-tax Officer determined the accumulated profits in the hands of the subsidiary company at Rs. 10,79,014 consisting of the following items:

Being aggrieved by the assessment order of the Income Tax Officer, the assessee-company appealed to the Appellate Assistant Commissioner who rejected the contention of the assessee. The assessee-company, therefore, came in appeal before the Tribunal.. The Tribunal while applying the provisions of section 2(22)(e) of the Income Tax Act upheld the contention of the assessee that for the assessment year 1971-72 the entire accumulated loan of Rs.26,64,856 over the assessment years 1969-70, 1970-71 and 1971-72 could not be taken into account for applying the provisions of section 2(22)(e). The Tribunal held that only the loan received by the assessee during the assessment year 1971-72 should be taken into account for the purposes of section 2(22)(c). Accordingly, it recalculated the deemed income of the assessee under section 2(22)(e) for the assessment year 1971-72 as Rs.2,83,346 and included the same in the income of the assessee for the assessment year 1971-72.

From the findings of the Tribunal, three questions are referred to us at the instance of the assessee, while the fourth question is referred to us at the instance of the Revenue:

"(1) Whether section 2(22)(e) can be made applicable in the case of a corporate body like the assessee-company which holds 100 percent. shares of the subsidiary company?

(2) Whether, on the facts and in the circumstances of the case, the appropriations made to the development rebate reserve account in the accounts of the subsidiary company up to March 31, 1970, were accumulated profits of the said company for the purpose of determining the amount of dividend under section 2(22)(e) in the hands of the assessee?

(3) Whether, on the facts and in the circumstances of the case, the sum of Rs.2,83,346 was includible in the assessment of the assessee for 1971-72 under section 2(22)(e)?

(4) Whether, on the facts and in the circumstances of the case, the accumulated profits of the subsidiary company up to the end of the assessment year 1970-71 have to be ignored for determining the amount taxable as dividend in the hands of the assessee for the assessment year 1971-72 under section 2(22)(e)?"

Section 2(22)(e) of the Income Tax Act, 1961, as in force at the relevant time gives the definition of "dividend". It states that:

"`dividend' includes---...

(e) any payment by a company, not being a company in which the public are substantially interested, .of any sum (whether as representing a part of the' assets of the company or otherwise) by way of advance or loan to a shareholder, being a person who has a substantial interest in the company, or any payment by any such company on behalf, or for the individual benefit, of any such shareholder, to the extent to which the company in either case possesses accumulated profits: ....

Explanation 1; --The expression `accumulated profits', wherever it occurs in this clause, shall not include capital gains arising before the 1st day of April 1946, or after the 31st day of March 1948, and before the 1st day of April, 1956.

Explanation 2.---The expression `accumulated profits' in sub-clauses {a), (b), (d) and (e), 'shall include all profits of the company up to the date of distribution or payment. referred to in those sub-clauses and in sub-clause (c) shall include all profits of the company up to the date of liquidation but shall not, where the liquidation is consequent on the compulsory acquisition of its undertaking by the Government or a corporation owned or controlled by the Government under any law for the time being in force, include any profits of the company prior to three successive previous years immediately preceding the previous year in which such acquisition took place:'

Under section 8(a) of the Income Tax Act, 1961, for the purposes of inclusion in the total income of an assessee any dividend declared by a company or distributed or paid by it, 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 (22) of section 2 shall be deemed to be the income of the previous year in which it is so declared, distributed or paid, as the case may be. Therefore, what has to be taken into account is the payment received by the company during the relevant previous year which is to be included in dividend by virtue of section 2(22)(e). In view of this clear position of the Income Tax Act, question No.4 which is referred to us at the instance of the Revenue has to be answered in the affirmative and in favour of the assessee because what we have to take into account for the purposes of section 2(22)(e) for inclusion as dividend income of the assessee is the amount received by the assessee ?company as a loan of the kind set out in section 2(22)(e) in the assessment year 1971-72. In this connection, we agree with the reasons of the Tribunal given in para 11 of its order.

It is urged by the assessee-company that the provision of section 2(22) cannot apply to a company which has a substantial interest in another company, i.e. the provisions cannot apply to a holding company or a subsidiary company but can only apply to an individual or a person who has a substantial interest in the company. This submission has to be rejected in view of the definition of "person" under section 2(31) which includes a company and the definition of "a person who has a substantial interest in the company" given in section 2(32). In fact, our High Court in the case of Sadhana Textile Mills Pvt. Ltd. v. CIT (1991) 188 ITR 318 has expressly dealt with this question and has held that section 2(22)(e) applies to a holding company and a subsidiary company. The second submission which was made on behalf of the assessee was to the effect that section 2(22)(e) cannot apply where the corporate body holds 100% shares of the subsidiary. It will only apply to a case where the holding company has a substantial interest in the subsidiary company. We fail to appreciate this submission. Having a 100% interest is the same as having a substantial interest. In the premises question No.1 which is referred to us at the instance of the assessee is answered in the affirmative and against the assessee.

The next submission of the assessee is to the effect that while calculating the accumulated profits of the subsidiary company, the appropriations made to the development rebate reserve account in the relevant assessment year should not be taken into account as, according to the assessee, the development rebate reserve does not form a part of the accumulated profits of the company. In this connection, our attention was drawn to. the provisions of section 34(3)(a) under which it is provided that the deduction referred to in section 33 shall not be allowed unless an amount equal to 75% of the' development rebate to be actually allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during the period of 8 years next following for the purposes of the business of the undertaking, other than for distribution by way of dividends or profits. In view of this restriction placed on the development rebate reserve, the assessee contends that this amount should not be considered as forming part of the accumulated profits of the assessee-company for the purposes of section 2(22)(e) since this amount is not available for distribution as dividend. The Explanation to section 2(22)(e), however, which explains the expression "accumulated profits" in section 2(22) does not support this contention of the assessee. Explanation 1 to section 2(22) clearly provides what is excluded from the ambit of this expression. It only excludes capital gains arising over a certain period of time. The position is further clarified by Explanation 2 which says that the expression "accumulated profits" in sub? clauses (a), (b), (d) and (e) shall include all profits of the company up to the date of distribution or payment referred to in those sub-clauses.

The Supreme Court in the case of P.K. Badiani v. CIT (1976) 105 ITR 642 has held that the term "profits" appearing in section 2(6A)(e) of the Indian Income-tax Act, 1922, which corresponds to section 2(22)(e) of the Income Tax Act, 1961, means profits in the commercial sense, i.e., profit: made by the company in the usual and true sense of the term. It has also held that development rebate reserves created out of the company's profit; constitute a part of the accumulated profits of the company. In view of this judgment, it is clear that the development rebate reserves created by the subsidiary company form a part of the accumulated profits for purposes of section, 2(22)(e).

In the premises, question No.2 which is referred to us is answered it the affirmative and in favour of the Revenue. In view of our answer to questions Nos. 1 and 2, question No. 3 is also answered in the affirmative and in favour of the Revenue. No order as to costs.

M.BA./141/T.F.?????????????????????????????????????????????????????????????????????? Order accordingly.