Capital gains are excluded from commercial profits when judging dividend distributability under section 23A.

Capital gains realised on the sale of a capital asset are not ordinarily part of commercial profits for determining the "smallness of profits" under section 23A of the Income-tax Act, 1922. The provision requires dividend distribution to be judged on commercial principles from the standpoint of a prudent businessman, not by treating every item of assessable income as distributable profit. The text distinguishes business profits from capital gains and notes that capital receipts are usually needed for asset replacement or re-employment in the business rather than dividend distribution. Taxability alone does not convert capital gains into commercial or accounting profits.

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Issues: Whether capital gains realised by a company on sale of a capital asset were includible in commercial profits for determining the "smallness of profits" under section 23A of the Income-tax Act, 1922.

Analysis: Section 23A required the Income-tax Officer to judge the reasonableness of dividend distribution on commercial principles and from the standpoint of a prudent businessman, not by treating all assessable income as commercial profit. The statutory scheme distinguished business profits from capital gains, and the legislative history showed that capital gains were treated differently for tax purposes. Amounts received as capital gains were accidental and occasional receipts of capital character and would ordinarily be needed for replacement of assets or re-employment in the business rather than distribution as dividend. The fact that such gains were taxable income did not convert them into commercial or accounting profits.

Conclusion: Capital gains were not includible in commercial profits for the purpose of section 23A, and the question was answered in the negative, in favour of the assessee.

Final Conclusion: For the purpose of section 23A, commercial profits must be determined on business principles, and capital gains of a capital nature do not ordinarily form part of the distributable profits of a company.

Ratio Decidendi: For section 23A, only actual commercial or accounting profits earned on business principles are relevant, and taxable capital gains do not become commercial profits merely because they are assessable to income-tax.

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