High Court upholds tax deduction on inter-corporate dividends under Income-tax Act 1961

The High Court of Bombay held that the deduction of tax on inter-corporate dividends in the hands of the assessee was properly allowed under Section 85A of the Income-tax Act, 1961. The Court determined that the deduction is based on the average rate of tax on the total income, not solely on dividend income. The Court emphasized that Section 85A does not specify a particular rate for dividend income but allows for a deduction from the general average rate. Consequently, the Court upheld the calculations made by the Income Tax Officer and ruled in favor of the revenue, requiring the assessee to pay the costs of the reference.

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Issues:
Interpretation of Section 85A of the Income-tax Act, 1961 regarding deduction of tax on inter-corporate dividends in the hands of the assessee.

Analysis:
The High Court of Bombay addressed the issue of whether the deduction of tax on inter-corporate dividends in the hands of the assessee was properly allowed under Section 85A of the Income-tax Act, 1961. The assessee, a private limited company, derived income from business, dividends, and capital gains during the assessment year 1965-66. Section 85A allows for a deduction of tax on dividends received by a company from an Indian company or a company with prescribed dividend arrangements. The total dividend income of the assessee was Rs. 6,35,408, with a portion exempt from tax under Section 84 of the Act. The Income Tax Officer (ITO) calculated the deduction under Section 85A at Rs. 1,83,654.02 based on the average rate of tax on the total income. The assessee appealed to the Appellate Assistant Commissioner (AAC), citing legislative history and the aims of Section 85A, but the AAC upheld the ITO's computation.

The matter was further appealed to the Tribunal, where the counsel argued that the average rate of tax on inter-corporate dividends should be considered, not the total income rate. The Tribunal dismissed the appeal, stating that the average rate of tax should apply uniformly to all dividend income. The High Court considered the statutory position before Section 85A and the definition of "average rate of income-tax" in Section 2(10) of the Act. The Court held that the deduction under Section 85A is calculated based on the average rate of tax on the total income, not just on dividend income. Referring to a Calcutta High Court decision, the Court emphasized that Section 85A provides for a deduction from the general average rate and does not prescribe a specific rate for dividend income. Therefore, the calculations made by the ITO were deemed correct, and the deduction was properly allowed as required by Section 85A.

As a result, the High Court answered the reference question in the affirmative and in favor of the revenue, requiring the assessee to pay the costs of the reference.

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