Commercial profits govern dividend reasonableness under section 23A; capital gains kept in reserves were not distributable business profits.

Capital gains realised on sale of a capital asset were taxable income, but for judging the reasonableness of dividend under section 23A of the Income-tax Act, 1922, the controlling test was commercial profit and not assessable income alone. The Court applied the principle that smallness of profit must be determined on commercial principles. On the facts, the gains were transferred to reserves and not brought into the profit and loss account, so they did not ordinarily form part of distributable business profits. The section 23A order was therefore held not justified.

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Issues: Whether capital gains realised on sale of a capital asset and placed in reserves formed part of the company's business profits for the purpose of determining the reasonableness of dividend under section 23A of the Income-tax Act, 1922.

Analysis: The material distinction was between assessable income and commercial profits. Capital gains were taxable as income under the Act, but the decisive question under section 23A was whether they formed part of the company's actual commercial profits available for dividend distribution. The Court followed the principle that smallness of profit under section 23A must be judged on commercial principles, not by reference to assessable income alone. It accepted that capital gains may, in some exceptional circumstances, be treated as distributable, but where the entire surplus from the sale of a capital asset is carried to reserves and not brought into the profit and loss account, such gains do not ordinarily become business profits for testing the reasonableness of dividend declared.

Conclusion: Capital gains of the assessee did not form part of its business profits for the purpose of section 23A on the facts of the case, and the order under section 23A was not justified.

Final Conclusion: The reference was answered against the Revenue and the assessee succeeded on the substantive question of whether the realised capital gains could be treated as commercial profits for dividend-distribution purposes.

Ratio Decidendi: For section 23A, the sufficiency of dividend must be judged by commercial profits and not by assessable income; realised capital gains are not automatically business profits unless they are in fact treated as such in the company's accounts and circumstances justify their inclusion in distributable surplus.

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