Commercial profits test under dividend provisions includes penal interest, but not depreciation already allowed without proof of higher commercial depreciation.

Penal interest actually incurred by a company may be taken into account when judging the smallness of profits on commercial principles for dividend distribution under section 23A(1), because it is an outgo connected with profit-making activity. By contrast, the difference between depreciation claimed and depreciation allowed cannot be treated as a further reduction unless there is proof that commercial depreciation was higher than the amount already allowed under the Act. The same depreciation difference also cannot be deducted again from the undistributed balance for additional super-tax computation in the absence of a factual basis for any higher commercial allowance.

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Issues: (i) Whether penal interest paid under section 18A and the difference between depreciation claimed and depreciation allowed could be taken into account while judging the smallness of profits for the purpose of section 23A(1) of the Indian Income-tax Act, 1922. (ii) Whether the difference between depreciation claimed and depreciation allowed could be deducted from the undistributed balance of total income for computing additional super-tax under section 23A(1) of the Indian Income-tax Act, 1922.

Issue (i): Whether penal interest paid under section 18A and the difference between depreciation claimed and depreciation allowed could be taken into account while judging the smallness of profits for the purpose of section 23A(1) of the Indian Income-tax Act, 1922.

Analysis: For the purpose of the proviso to section 23A(1), the relevant enquiry is whether, on commercial principles, the profits available for distribution were so small that declaration of dividend would be unreasonable. Penal interest paid by the company, though not deductible in computing assessable income for the first part of section 23A, is nevertheless an outgo connected with the profit-yielding activity and must be considered in assessing distributable commercial profits. The claimed-versus-allowed depreciation difference, however, had already been taken into account in computing assessable income, and no material showed that the allowance under the Act was lower than what commercial principles required.

Conclusion: Penal interest was rightly taken into consideration, but the depreciation difference was not rightly taken into account for judging smallness of profits. This issue is partly in favour of Revenue and partly against the assessee.

Issue (ii): Whether the difference between depreciation claimed and depreciation allowed could be deducted from the undistributed balance of total income for computing additional super-tax under section 23A(1) of the Indian Income-tax Act, 1922.

Analysis: Once depreciation had been allowed in the computation of assessable income, it could not be deducted again from the undistributed balance for the purpose of additional super-tax unless a higher commercial depreciation was shown to be warranted. No such factual basis was established. The claimed difference was therefore not an allowable further deduction in the section 23A computation.

Conclusion: The deduction of the depreciation difference from the undistributed balance was not justified. This issue is in favour of Revenue.

Final Conclusion: The reference was answered by upholding consideration of penal interest in the smallness-of-profits enquiry, while rejecting the assessee's depreciation-based claim for both the profitability test and the super-tax computation under section 23A(1).

Ratio Decidendi: For section 23A(1), penal interest actually incurred as part of the company's commercial outgoings must be considered in judging smallness of profits, but depreciation already allowed in computing assessable income cannot be deducted again in the absence of proof that commercial depreciation was higher.

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