1. The assessee is a limited company and it make up its accounts at the end of December every year. In the statement of account for the year ended 31st December, 1948, the profit for that year was shown at Rs. 28,56,977-14-2. To this was added a sum of Rs. 37,948-11-9 being the profit brought forward from the last year. The directors made the fallowing appropriation of these profits. They allocated a sum of Rs. 2,25,000 to depreciation fund, Rs. 12,50,000 towards provision for income-tax, corporation tax and business profits tax, Rs. 11,08,000 to reserve fund, and Rs. 1,50,000 to dividend reserve fund. This left a balance of Rs. 1,61,946 and this amount they recommended should be expended in payment of dividend, leaving a balance of Rs. 89,134 which they recommended should be carried forward to next year's account. The directors made their report on 27th April, 1949. A general meeting of the shareholder was held on the 27th June, 1949, and they accepted the report and the recommendations of directors assessee company was assessed to business profits tax for the chargeable accounting period 1st January, to 1st March, 1949, and the question that arose for consideration was, what was the capital of the company for the accounting period The company's contention was that the paid-up capital should be increased by the amount of reserves which had been constituted by the recommendation made by the directors and accepted by the shareholders and the company made this claim in respect of the three amounts of Rs. 12,50,000, Rs. 11,08,000 and Rs. 1,50,000. The Tribunal accepted the contention of the assessee company with regard to the reserve fund of Rs. 11,08,000 and dividend reserve fund or Rs. 1,50,000. With regard to the provision for payment of tax the view taken by the Tribunal was that that was a provision for payment of tax the view taken by the Tribunal was that a provision made for a liability and did not constitute a reserve, but if made a recommendation to the Income-tax Officer that if the amount set apart to meet this liability exceeded the actual liability, then to the extent of the excess of the amount should be treated as reserve. The Commissioner has how come on this reference and the question that has been submitted to us for our consideration is whether the two sums of Rs. 11,08,000 and Rs. 1,50,000 constitute a reserve as of the 1st January, 1949. The rival contentions are the as this was reserve that appeared in the balance sheet as of the 31st December, 1948, it was a reserve on the 1st January, 1949, and must be taken into account in computing the capital according to the provisions of the Business Profits Tax Act. The contention of the Commissioner on the other hand is that this reserve was not sanctioned till the 27th June, 1949, and therefore, prior to that date it could not be looked upon as reserve.
2. Now, there is no doubt in this case that these amounts - and we will deal for the time being only with the regard to the amounts appropriated to the reserve fund and the dividend reserve fund - did constitute reserves. The only question is as to the date when they constituted reserves. It is undoubtedly true that the function of the directors under the Companies Act is to make a recommendation as to how the profits should be distributed or allocated and it is the right of the shareholder ultimately to decide at a general meeting. There were profits were in the sum of Rs. 28,94,946-11-0, and these profits had to be dealt with by the directors and in respect of then recommendation had to be made by the directors, and the company; any law all provides that dividend must be declared out of these profit after all the necessary appropriations have been made, and therefore the directors proceeded to make the appropriations and the appropriation included the taking of a sum of Rs. 11,08,000 to the reserve fund and a sum of Rs. 1,50,000 to the dividend reserve fund. Now, when this recommendations came before the shareholders at the general meeting, what the shareholders accepted and adopted in the form of a resolution was that these amounts constituted reserves as of the 31st December, 1948. The fallacy underlying the Commissioner's contention is that these amounts constituted reserves as of the 27th June, 1949, when the resolution was passed. Although the resolution was passed on the 27th June, 1949, resolution obviously had a retrospective effect and it referred to the profits of the year ending on 31st December, 1948, to the appropriations to be made in the balance sheet as of the 31st December, 1948, and the reserves that should be constituted and shown in the balance-sheet as of the 31st December, 1948, these amounts are shown respectively in the reserve fund and the dividend reserve fund. Therefore, the shareholders bypassing a resolution on the 27th June, 1949, did not decide that these amounts should constitute reserves as from that date, but they accepted the recommendation of the directors that these amounts should constitute reserves of the company as of the 31st December, 1948. The Advocate-General says that there must be someone with the requisite authority who can decide that a certain amount should constitute reserve. The directors under the Companies Act do not have the requisite authority, only the shareholders have it, and till somebody had decided to this effected to this no part of the profit can become reserves. Now, that proposition is perfectly sound, but in advancing that argument what is overlooked is that the body of shareholders who are the persons with the requisite authority do not merely determine that a certain amount should constitute reserve, but they also determine and have necessary authority for determining that that amount should constitute reserve as from a particular date, and its this case there is no doubt that the general meeting of the shareholders was considering the accounts for the year ended 31st December, 1948, and passing resolution with regard to those accounts.
3. Reliance has been placed on two decisions by the Advocate-General. In our opinion, neither of these two has any bearing on the question that we have to decide on this reference. The first is a judgment of the Supreme Court reported in Commissioner of Income-tax v. Century Spinning and . In that case the question was whether a sum of Rs. 5,08,637 could be called a reserve, and the Supreme Court held that that amount did not constitute a reserve. The facts there were very peculiar. This amount was earmarked by the directors for distribution as dividend, it had never been set apart as reserve, and the view taken this Court, which view was not accepted by the Supreme Court, was that as that amount constituted undistributed profits they must be looked upon as having been set apart till they were actually appropriated for the purpose of payment of dividend. As we have pointed out, that view was not accepted by the Supreme Court and the Supreme court held that nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination and the fact that that amount constituted of its disposal or destination and the fact that that amount constituted a mass of undistributed profits could not automatically make it a reserve. Therefore, it will be noticed that in the case before the Supreme Court there was no reserve at all the therefore no question arose as to when the reserve could be considered as having been constituted.
4. In the other case to which reference is made, which is an unreported decision in Commissioner of Income-tax, Bombay City v. India United Mills, Ltd. Income-tax Reference No. 46 of 1954 decided on 18th February, 1955, the question was whether reserve an amount of profits carried forward to the next year could constitute reserve, and we held following the decision of the Supreme Court that that amount could not be considered as reserve. There again, no portion of the profits had been earmarked for reserve, nor had the shareholders accepted the recommendation of the director that a particular amount should be taken to the reserve fund. In the case before us we have this distinguishing feature that certain amounts have been earmarked by the directors as reserve, and the shareholders have accepted the recommendation and passed a resolution at the general meeting.
5. On principle, too, the contention put forward by the Commissioner seems to us to be untenable. The business profits tax gives to a businessman certain abatement in respect of reserve because reserve are looked upon as standing on the same footing a capital. It that be the principle underlying taxation under the business profit tax, the it is difficult to understand why a business should not get the benefit of the reserves actually utilised by the company for the working of the company. In this case the profits were made at the end 31st December, 1948, and from 1st January, 1949, the reserves were in existence and could be utilised for the working of the company as much as the capital. If that be so, the mere fact that the shareholders passed a resolution at a later date cannot affect the merits of the question or the right of the assessee company to get the benefit of the abatement provided by the business profits tax.
6. A question has also been sought to be raised by a notice of a motion taken out by the Commissioner, and what sought to be argued on this notice of motion by the Advocate-General was that the Tribunal was in error when to directed the Income-tax Officer with regard to the sum of Rs. 12,50,000 to permit a part of it which was not utilised for, meeting the liability with regard to taxation as reserve. There may be force in the Advocate-General's contention on this point, but we do not find that this contention has ever been raised by the Commissioner either on his application to the Tribunal to make a reference or in the notice of motion taken out before us. The question which the Commissioner suggests should be raised on the notice of motion is not different from the question raised by the Tribunal itself. The only virtue about the Commissioner's question is that it seeks to incorporate in the question arguments and facts which are already set of out in the statement of the case. Therefor, in our opinion, the notice of motion taken out by the Commissioner must fail.
7. The result is that we must answer the question submitted to us in the affirmative. The Commissioner to pay the costs of the reference and also the cost of the notice of motion.
8. Question answered in the affirmative.