JUDGMENT
S.T. Desai, J.
1. The question that arises for our determination in this references lies in an extremely narrow compass and relates to the meaning of the expression “reserves,” an expression which has not been defined i the Income-tax Act. The expressions occurs in section 23A of the Act and the controversy before us has centered round the meaning of the expression “reserves” in the proviso to sub-section (1) of that section. The facts of the case are brief. The income of the assessee, a private limited company, for the previous year 1951 (assessment year 1952-53) was determined at Rs. 5,85,085. The tax payable on it was Rs. 2,48,901 and the dividend declared by the company in a general meeting was Rs. 2,21,904. That was about 66% of the assessable income reduced by the tax payable there on and satisfied the requirements of sub-section 23A. But the Department took the view that the case of the fell within the first proviso to that sub-section and that this was case in which the company had not distributed as dividend 100 per cent. of its profits and therefore the fiction of law laid down in section 23A(I) should apply to the case and the undistributed profits of the company should be deemed to have been distributed. The first proviso to section 23A(I) is as under :
“Provided that when the reserves representing accumulations of past profits which have not been the subject of an order under this sub-section exceed the paid up capital of the company, together with any loan capital which is the property of the shareholders, or the actual cost of the fixed assets of the company whichever of these is greater, this section shall apply as if instead of the words ‘sixty per cent, ‘the words’ one hundred per cent.’ were substituted.”
2. The Income-tax Officer took the view that the reserves representing accumulation of past profits of the company exceeded the paid up capital of the company. The facts here are not in dispute. The balance-sheet of the company as at 31st December, 1951, showed its paid up capital at Rs 1,34,400, and the undistributed reserves representing accumulation of past profits amounted to Rs. 1,33,037. There was a charity account which showed an old credit balance of Rs. 1,000; and a sum of Rs. 3,156 brought forward from the earlier year in the profit and loss account was shown as the balance in the account. The director’s report for the preceding accounting year ended 31st December, 1950, showed that the profit available for distribution was Rs. 4,04,980. They had taken certain amount to taxation reserves and to the reserve fund of the company and a sum of Rs. 1,000 to charity and had recommended a declaration of a dividend. That had left the small balance of Rs. 3,156 on hand which the directors had recommended should be carried forward in the profit and loss account to the following year 1951. That recommendation of the board of directors had been accepted by the shareholders in the general meeting held on 24th May, 1951. The figures are eloquent and it will be noticed that the item of Rs. 1,34,400 and Rs. 1,33,037 are very close. Even if the amount of Rs. 1,000 of the charity be added to the reserves representing accumulations, that brings the total to Rs. 1,37,037 which very narrowly falls short of the line when the reserves might exceed the paid up capital. The contention of the Department was that the amount of Rs. 3,I56 which had been carried forword in the profit and loss account of the company from the previous year to the following year 1951 must be treated as reserves for the purpose of application of the first proviso to section 23A(1). We may observe that there is no suggestion that in this case there was any attempt on the part of the directors or the shareholders of the company to avoid the operation of the provisions of sub-section (1) of section 23A. The departmental authorities and the Tribunal to which the matter was carried in appeal took the view that this amount of Rs. 3,156 was reserves within the meaning of that expression in the proviso. The attention of the Tribunal was drawn to a decision of the Supreme Court but the Tribunal purported to distinguish that decision, though on our part we must say that it is difficult to see how the Tribunal has distinguished that decision. We shall presently refer to the same.
3. The questions which we are called upon to determine are :
“(1) Whether the sum of Rs. 3,156 can be included in determining reserves representing accumulations of past profits for the purpose of the first proviso to section 23A(1) ?
(2) If the answer to the above question is in the affirmative, whether the fact that the assessee company declared dividend of more than 60% of its ‘reduced assessable income’ precludes operation of the first proviso to section 23A(1) for the purpose of making an order under section 23A(1) ?”
4. It has been argued by Mr. Palkhivala, learned counsel for the assessee, that of the three conditions which must be fulfilled for the operations of the proviso, we are concerned in this references with the first which relates to the expression “reserves” in the initial part of the proviso and what is strictly “reserves” can be taken into consideration in applying the proviso for the purpose of seeing whether in the aggregate there is an excess of the reserves representing accumulated profits over the paid up capital of the company. The expression “reserves”, as we began by saying, has not been defined in the Income-tax Act and we have to interpret the expression on general principles and in the light of canons of construction applicable to taxing law.
5. Now, our task is made considerably easy by a decision of the Supreme Court in Commissioner of Income-tax v. Century Spinning and Manufacturing Co. Ltd., where their Lordship had to consider the identical expression, though not in the context of income-tax law but in the context of the Business Profits Tax Act of 1947 which also is a taxing statute. That statute also does not define the expression “reserves” and their Lordship observed that regard must be had to the ordinary natural meaning as understood in common parlance. After stating the dictionary meaning of the expression “reserves” the Supreme Court proceed to make certain general observations which, if we may respectfully say so, are instructive and afford considerable guidance. It is not necessary to state the facts of that case and we may only state that in that case one of the considerations was that there was a balance of profits which had been carried forward to the next year’s account.
6. At page 504 of the report, it is observed :
“The reserve may be a general reserve or a specific reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits on the 1st January, 1946, cannot automatically make it a reserve. On the 1st April, 1946, which is the commencement of the chargeable accounting period, there was merely but as dividend. Far from showing that the directors has made the amount in question a reserve it shows that they had made the amount in question a reserve, it shows that they had decided to earmark it for distribution as dividend. By the resolution of the shareholders on the 3rd April, 1946, the amount was shortly afterwards distributed as dividend………… The directors had no power to distribute the sum as dividend. They could only recommend, as indeed they did, and it was up to the shareholder of the company to accept that recommendation in which case alone the distribution could place. The recommendation was accepted and the dividend was actually distributed. It is, therefore not correct to say that the amount was kept back. The nature of the amount which was nothing more than the undistributed profits of the company, remained unaltered. Thus the profits lying unutilised and not specially set, apart for any purpose on the crucial date did not constitute reserves……”
7. It is notable that the Supreme Court emphasized that to amount to reserves there must be clear direction by the directors to that effect and it is that allocation by an act of volition on the part of the directors that can constitute reserves. Now, let us apply the test to the facts of the case and applying the test laid down by their Lordship it seems extremely difficult to see how this amount of Rs. 3,156 carried forward in the profit and loss account and not earmarked for any purpose not treated directly or indirectly as general reserves or special reserves and left as a massif undistributed profits, can be called “reserves” of the company. It has been urged by the learned counsel for the Department that the crucial date in the case before their Lordship of the Supreme Court was 1st April, 1946, and the crucial date here before us is 1st January, 1951. The suggestion is that at the crucial date this amount of Rs. 3,516 had already reserves. There is, our opinion, no foundation for this argument.
8. It was next urged by learned counsel for the Department that the proviso should be construed in the light of the substantive provision in section 23A. We agree that it must be so. Emphasis was laid on the expression “assessable income of the company” in sub-section 23A but that has little bearing on the construction of the expression “reserves” in the proviso. The reference to the expression “assessable income of the company” seems to have been made to emphasis the object of the legal fiction laid down in section 23A(1) and to show that the provisions contained in the proviso were made for the purpose of averting certain mischief being committed by private limited companies by following profits to accumulate without distributing the profits. It was said that people may go on collecting profits and the whole object and purpose of section 23A(1) is to prevent that being done; so that where the reserves exceeded the paid up capital, the whole amount would have to be distributed and if that was not done the rule relating to notional distribution would come into force. We agree that the object of section 23A(1) is as stated by learned counsel. Now, this argument would certainly have considerable force if the case of the Department was that in this case the substance of the matter was different than that appearing from the facts already narrated by us. But as we have already said that is not the contention of the Department in this case. There may conceivably be cases where, by certain manipulation of figures and resolutions, an attempt may be made to accumulate profits by describing them under different heads with the object of showing that they were not reserves and with a view to avoiding the application of the proviso. Now, this aspect of the matter was indubitably present to the mind of their Lordship of the Supreme Court, when they observed at page 504 in the case of Century Spinning and Manufacturing Co. Ltd. :
“What is the true nature and character of the disputed sum, must determined with reference to the substance of the matter and when this is borne in mind, it follows………..”
9. The substance of the matter before us is that practically the whole of the available profit was either taken to the reserves or distributed as dividend and only a small amount of Rs. 3,156 was carried forward in the profit and loss account. Therefore, applying the test which found favour with the Supreme Court, we must hold that this amount cannot be treated as reserves of the company.
10. Our answer to the first question will be in the negative.
11. In view of our opinion on the first question, it is unnecessary to answer the second question.
12. Commissioner to pay the costs.
13. References answered accordingly.
