1. The assessee in the National City Bank of New York and the assessment are under the Business Profits Tax Act, and the contention of the bank was that certain amounts which it described as 'undivided profits' should be treated as reserves and added to its capital for the purpose of computing its taxable income under the Business Profits Tax Act. The Tribunal rejected this contention and the bank has come on this reference.
2. Now, in view of the Supreme Court decision in Commissioner of Income-tax, Bombay City v. Century Spinning and . it is well settled as to what constitutes a reserve. A corporation might make profits should be dealt with. They might declare a dividend out of these profits if the profits can bear the declaration of a dividend. They might transfer certain amounts a general or specific reserve and there would be a balance left over which will be carried forward to the credit of the profit and loss account. If the profits are not allocated or appropriated to a general or a specific reserve by a deliberate act on the part of the directors, there unappropriated profits cannot and do not constitute a reserve. The mere fact that these profits remain in the business and are utilised by the company for the purpose of its business do not constitute them general reserves. What the Supreme Court emphasised was that there must be a clear direction by the directors that a portion of the profits have to be allocated for a specific purpose and it is that allocation by an act of volition on the part of the directors that constituted the reserve. Applying that test to the facts of this case, in our opinion, it is abundantly clear that that test is not satisfied and the claim made by the bank that its undivided profits constitute a reserve cannot be accepted.
3. We have before us a report of this bank to its shareholders and at page 4 it points out :
'At the year end, capital of the bank remains at 77,500,000 Dollars. Surplus has increased to 152,500,000 Dollars by the transfer of 10,000,000 Dollars from undivided profits. After this transfer, undivided profits are 29,534,614 Dollars, an increase of 240,376 Dollars from a year ago.'
4. Therefore, what the bank did was to transfer 10,000,000 Dollars from its undivided profits to surplus which it is common ground constitutes a general reserve. Therefore, the only act of volition, the only deliberate act, on the part of the bank or its directors was the transfer of 10,000,000 Dollars transferred to surplus, but what was left of the balance of profits was transferred to undivided profits. What is strenuously urged is that in the system of book-keeping adopted by the assessee and also by other American banks in the United States, the balance of profit is not carried forward to the next profit and loss account, but it is set apart and transferred to an account known as 'undivided profits.' It is clear that a mere nomenclature or a mere method of book-keeping cannot constitute unappropriated profits into a reserve. We must always look for, as the Supreme Court asks us to look for, some act, some clear direction, given by those in authority, ear-marking the profits or portion of them for a particular or specific purpose, and when we look at the accounts it is clear that this so called undivided profits account is nothing else that what our bankers in India would describe as a profit and loss account. At page 5 we have the account of 'current operating earnings' and 'current operating expenses', and the account for 1946 shows that there was net current operating earnings in the sum of 17,573,826 Dollars. Then we have an account set our called 'reconcilement of surplus and undivided profits'. In this account we have this sum of 17,573,826 Dollars, which is the net current operating earnings, then net profits from sales of securities which is 3,717,892 Dollars, and the total is 21,291,718 Dollars.Frim this is deducted
5. dividends declared which is 9,300,000 Dollars, transfers to special purpose reserves which is, 1,751,342 Dollars, leaving a balance of 11,051,342 Dollars. To this is added the sum of 10,240,376 Dollars which is the new addition for period under consideration, and the balance in this account at the beginning of the period was 171,794,238 Dollars and the balance at the end of the period is shown as 182,034,614 Dollars. When we turn to the balance sheet this sum of 182,034,614 Dollars is shown as surplus 152,500,000 Dollars and undivided profits 29,534,614 Dollars. Therefore, of the 182,034,614 Dollars which constitute the undivided profits, by various resolutions or directions of the directors or of the bank, 152,500,000 Dollars have been transferred to surplus which, as we have pointed our before, is the general reserve, leaving to the credit of this account 29,534,614 Dollars. How it is possible to urge that this balance of 29,534,614 Dollars, with regard to which no direction has been given, which has never been transferred to any reserve, which has never been earmarked for any particular purpose, constitutes a reserve it difficult to understand.
6. Our attention was drawn by Mr. Palkhivala to a letter written by the Deputy Comptroller of the Currency to the Comptroller, National City Bank of New York, which sets our the practice followed by the bank with regard to these undivided profits, and that letter clearly supports the contention of the Department that undivided profits do no constitute a reserve within the meaning of the decision of the Supreme Court. Mr. Jennings, the Deputy Comptroller of the Currency, points our that the term 'undivided profits' is a banking term used in the United States and that the nearest equivalent to the term in business accounting is earned surplus, and that the new addition for the year to undivided profits is the net income for the year after declaration of dividends and provisions for specified reserves. If you paraphrase this in the language of Indian accountancy it means that undivided profits are unappropriated profits after the dividends have been declared and various amounts have been allocated to different reserves. There is no magic about the expression 'undivided profits'. You May call the appropriated profits or profits without any qualification whatsoever, but it is clear that they are profits which have not been earmarked for any particular purpose. Again, this gentleman says :
'The term 'undivided profits' simply follows a bank accounting nomenclature used in the United States to designate profits set aside, after provisions for expenses and taxes, dividends and reserves, for continuous future use in the business of the bank, and it bears a close, if not identical, relationship to the earned surplus account of an industrial corporation.'
7. Mr. Palkhivala puts emphasis on the expression 'set aside'. But set aside by whom They are set aside of their own accord by reason of the fact that various amounts have been allocated and the balance or the surplus remains unallocated. Mr. Jennings also points out that the undivided profits constitute an integral part of the capital structure of the bank, and Mr. Palkhivala has also drawn our attention to reports of other banks of the United States where undivided profits in the United States, but whether according to our law these profits constitute reserve, not reserve in any general popular sense but reserve in the sense in which the Supreme Court has defined this expression.
8. It is true, as Mr. Palkhivala points our, that these large amounts remain with the bank, that the bank uses them, that business is carried on with the help of those funds, and that they are as much capital of the bank as capital in the strict sense of the term. While accepting all those contentions, the fact remains that these undivided profits do not satisfy the test laid down by the Supreme Court. Our attention was them drawn to certain instructions issued by the united States Government to bankers with regard to the preparation of their report, and those instructions really clinch the matter because in those instructions capital accounts are enumerated as capital stock, surplus and undivided profits, and with regard to undivided profits it is stated :
'This item should represent the amount of undivided profits as shown by the bank's books, after deduction from capital stock'.
9. It the bank's book show a debit balance in its 'undivided profits' account, such balance should be deducted from surplus, or if it exceeds surplus the excess should be deducted from capital stock'.
10. Therefore, it is possible that in these undivided profits you May have a minus quantity. Now, whoever heard of a reserve being constituted by a minus quantity. This clearly shows that the only difference between account keeping in India and account keeping in United States is that in India you have profits and loss account; the balance at the foot of the account, whether it is profit or loss, after appropriation is carried forward to next year's profits and loss account. In America the profit and loss account is closed every year and whatever the balance it is carried forward to another account described as 'undivided profits', and the whole of Mr. Palkhivala's argument is that because the balance of the profit and loss account is carried forward to another account described as 'undivided profits', that by itself constitutes reserve. In our opinion, it is impossible to accept that contention in view of the decision of the Supreme Court.
11. The result is that we must answer the question in the negative.
12. The assessee to pay the costs.