Court includes capital gains in average rate for relief on inter-corporate dividends

The court held that the average rate of income-tax for computing relief under section 85A on inter-corporate dividends should include capital gains as part of total income, contrary to the assessee's argument. The court emphasized that the definition of "income" under section 2(24) encompasses capital gains, and the average rate should be calculated as per section 2(10). The court rejected the contention that including capital gains would lead to varying tax rates among companies, clarifying that section 85A provides for a deduction mechanism, not a fixed tax rate.

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Issues Involved:
1. Whether the average rate of income-tax should be worked out with reference to the total income of the company as reduced by the amount of capital gains for computing the relief u/s 85A on inter-corporate dividends.

Summary:

1. Background and Reference:
The case involves a reference made u/s 256(1) of the Income-tax Act, 1961, concerning the assessment year 1967-68. The question is whether the Tribunal was correct in holding that the average rate of income-tax should be computed by excluding long-term capital gains for the purpose of relief u/s 85A on inter-corporate dividends.

2. Tribunal's Decision:
The Tribunal had directed that long-term capital gains should be excluded from the total income for calculating the average rate of income-tax for the purposes of section 85A. This was based on the context in which "average rate of income-tax" was used in section 85A, suggesting it should be independent of section 2(10).

3. Relevant Provisions:
- Section 85A: Provides for a deduction of tax on inter-corporate dividends.
- Section 2(10): Defines the average rate of income-tax.
- Section 2(24): Includes capital gains as part of income.

4. Previous Judgments:
The court referred to the judgment in Birla Bombay P. Ltd. v. CIT [1980] 121 ITR 142, which held that the average rate of income-tax should be calculated as per section 2(10) without excluding capital gains. This view was also supported by the Calcutta High Court in ITO v. Raleigh Investment Co. Ltd. [1976] 102 ITR 616.

5. Assessee's Argument:
The assessee argued that the average rate for section 85A should exclude capital gains because the rate for capital gains is prescribed by the Income-tax Act (section 115) and not by the Finance Acts.

6. Court's Analysis:
The court found no warrant for excluding capital gains from the total income for calculating the average rate of income-tax u/s 85A. The court emphasized that "income" as defined u/s 2(24) includes capital gains, and the average rate of income-tax should be computed as per section 2(10).

7. Anomaly Argument:
The assessee contended that including capital gains would result in different tax rates for different companies, which was not the intention of section 85A. The court rejected this argument, stating that section 85A does not prescribe a tax rate but a deduction mechanism.

8. Circulars and External Aids:
The court examined Circulars No. 3-P and 4-P and found that they did not mandate a flat 25% tax rate on inter-corporate dividends but explained the mechanism of section 85A. The court held that these circulars did not bind the Revenue to levy tax only at 25%.

9. Conclusion:
The court concluded that there was no ambiguity in section 85A and no need to resort to external aids of interpretation. The question was answered in the negative, in favor of the Revenue, stating that the average rate of income-tax should include capital gains for the purposes of section 85A.

10. Costs:
There was no order as to costs.

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