Skip to content


Shree Ram Milis Ltd. Vs. Commissioner of Income-tax, Bombay City-i - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberSuper Profit Tax Reference No. 1 of 1972
Judge
Reported in[1977]108ITR27(Bom)
ActsSuper Profit Tax Act, 1963 - Schedule - Rule 1; Income Tax Act, 1961 - Sections 2(5) and 2(9), 4 and 34(3); Wealth Tax Act, 1957 - Sections 2
AppellantShree Ram Milis Ltd.
RespondentCommissioner of Income-tax, Bombay City-i
Appellant AdvocateD.H. Dwarkadas, Adv.
Respondent AdvocateR.J. Joshi, Adv.
Excerpt:
(i) direct taxation - provision for tax - schedule to rule 1 of super profit tax act, 1963, sections 2 (5), 2 (9), 4 and 34 (3) of income tax act, 1961 and section 2 of wealth tax act, 1957 - whether provision for taxation not liable for inclusion in capital computation for purposes of act of 1963 - liability of taxation having arisen on expiry of last day of year, setting apart sum will be regarded as provision for known and existing liability quantification whereof had to be done later - setting apart sum to meet known and existing liability be held as provision - held amount not liable to inclusion in capital computation. (ii) dividend - whether amount of proposed dividend liable to inclusion in capital computation for purposes of act of 1963 - no material to show recommendation of.....tulzapurkar, j.1. two questions, the first one at the instance of the assessee and the second one at the instance of the department, that have been referred to us for our opinion are : '(1) whether, on the facts and in the circumstances of the case, the tribunal erred in holding that the sum of rs. 22,75,000 being the provision for taxation is not liable for inclusion in the capital computation for the purposes of the super profits tax act, 1963 (2) whether, on the facts and in the circumstances of the case, the tribunal erred in holding that the sum of rs. 11,83,050 being the amount of proposed dividends is liable for inclusion in the capital computation for the purposes of the super profits tax act, 1963 ?' 2. the questions relate to the assessment made under the super profits tax act,.....
Judgment:

Tulzapurkar, J.

1. Two questions, the first one at the instance of the assessee and the second one at the instance of the department, that have been referred to us for our opinion are :

'(1) Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the sum of Rs. 22,75,000 being the provision for taxation is not liable for inclusion in the capital computation for the purposes of the Super Profits Tax Act, 1963

(2) Whether, on the facts and in the circumstances of the case, the Tribunal erred in holding that the sum of Rs. 11,83,050 being the amount of proposed dividends is liable for inclusion in the capital computation for the purposes of the Super Profits Tax Act, 1963 ?'

2. The questions relate to the assessment made under the Super Profits Tax Act, 1963, in respect of the assessment year 1963-64 for which the corresponding previous year was the calendar year ended on December 31, 1962. The assessee which is a public limited company claimed in the assessment proceeding under the Super Profits Tax Act, 1963, two items as being includible in the computation of its capital under the Second Schedule of the Act, viz., (i) provision for taxation : Rs. 22,75,000 and (ii) proposed dividend : Rs. 11,83,050. In regard to the first item, being provision for taxes in the sum of Rs. 22,75,000, the Income-tax Officer held that it could not be said to be a 'reserve' within the meaning of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, and in that behalf reliance was placed by him upon the decision of the Supreme Court in the case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax : [1966]59ITR767(SC) . He, accordingly, excluded the item from the capital computation. Similarly, in regard to the other item of proposed dividends in the sum of Rs. 11,83,050, he excluded the same from the capital computation on the ground that it represented an amount which had been set aside to meet a known and immediate liability to be discharged towards the shareholders and it could not, therefore, be a 'reserve'. Feeling aggrieved by this order of the Income-tax Officer passed on March 31, 1967, the assessee preferred an appeal to the Appellate Assistant Commissioner, who upheld the decision of the Income-tax Officer as regards both the items by his order dated September 27, 1967. He took the view that, in the light of the decision of the Supreme Court in Kesoram Industries and Cotton Mills Ltd.'s case : [1966]59ITR767(SC) , the provision made for taxation liabilities was a 'debt' as at the end of the accounting year and, therefore, at the crucial date it would be a provision and not a reserve. As regards the item of proposed dividend he took the view that it was an amount of provision for an apprehended and impending liability to be discharged towards the shareholders and, in view of the definition given in the Companies Act of the expression 'provision' and 'reserves', he confirmed the exclusion of the said item from capital computation. The matter was then carried by the assessee in second appeal to the Income-tax Tribunal. The Tribunal upheld the decision of the lower authorities in regard to the exclusion of the provision for taxation but reversed their decision as regards the item of proposed dividends (Rs. 11,83,050) and while reversing the decision of the lower authorities as regards the item of proposed dividends the Tribunal observed thus :

'We also direct the inclusion of Rs. 11,83,050 in the computation of capital. This amount has been set apart by persons competent to do so. It will not represent any actual liability till it is declared by the general body of shareholders. It is open to the shareholders to reduce the amount of dividends proposed by the directors and to cancel it even. In our opinion, this amount has to be treated as a 'reserve' and included in the computation of capital.'

3. As stated above, the first question has been referred to this court at the instance of the assessee while the second question has been referred to us at the instance of the department. We shall deal with these two questions separately though for both the material provisions of the Act that are required to be considered they are the same.

4. Under section 4 of the Act, there shall be charged on every company for every assessment year commencing on and from 1st April, 1963, a tax, called the super profits tax, in respect of so much of its 'chargeable profits' of the previous year as exceed the 'standard deduction', at the rate or rates specified in the Third Schedule. Section 2(5) defines the expression 'chargeable profits' to mean the total income of an assessee computed under the Income-tax Act, 1961, for any previous year and adjusted in accordance with the provisions of the First Schedule, while section 2(9) defines the expression 'standard deduction' to mean an amount equal to six per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of fifty thousand rupees, whichever is greater. In order to determine 'standard deduction' it becomes necessary to compute the capital of the company in accordance with the rules laid down in the Second Schedule and rule 1 is relevant for our purposes, the material portion whereof runs as follows :

'1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the sum of the amounts, as on the first day of the previous year relevant to the assessment year, of its paid up share capital and of its reserve, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922, or under sub-section (3) of section 34 of the Income-tax Act, 1961, and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purposes of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961, ...'

5. It will be clear from the aforesaid provision of rule 1 that before any amount or sum qualifies for inclusion in capital computation of a company two conditions are required to be fulfilled-(a) that the amount or sum must be a 'reserve', and (b) the same must not have been allowed in computing the company's profits for the purposes of the 1922 Act or the 1961 Act. That the two items in the instant case had not been allowed in computing the assessee's profits under the 1961 Act, has not been disputed; in other words, the second condition indicated above has been satisfied. The question is whether either of the two items amounts to or falls within the expression 'other reserves' occurring in the said rule.

6. Mr. Dwarkadas, appearing for the assessee, has contended before us that in regard to the item of Rs. 22,75,000 being the provision for taxation the same has been erroneously held by the taxing authorities as well as by the Tribunal as not a 'reserve' and, therefore not liable for inclusion in the capital computation for the purpose of the Super Profits Tax Act, 1963. He contended that, having regard to the principles that have been enunciated by the Supreme Court in the case of Commissioner of Income-tax v. Century Spinning and . : [1953]24ITR499(SC) , the provision for taxation that was made by the directors while appropriating the surplus will have to be regarded as falling within the expression 'reserve' occurring in rule 1 in the Second Schedule to the Super Profits Tax Act, 1963. He pointed out that, having regard to the dictionary meaning of the expression 'reserve' to which the Supreme Court has alluded in its judgment, if a body of persons possessing the requisite authority had indicated on the relevant date the manner in which a part of undistributed mass of profit earned by the company was to be disposed of, it could be regarded as a reserve and, according to him, in the instant case, the board of directors of the company, who possessed the requisite authority, had, in its report, clearly indicated that from out of the gross profits indicated by the profit and loss account a sum of Rs. 22,75,000 had been set apart for the purpose of taxation and, therefore, the provision for taxation of Rs. 22,75,000 made in the instant case by the board of directors should be regarded as a reserve within the meaning of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. It is not possible to accept this contention of Mr. Dwarkadas for the reasons which we shall presently indicate.

7. It is true that the expression 'reserve' has nowhere been defined in the Super Profits Tax Act, 1963, but it cannot be disputed that there is a clear-cut distinction between a provision and a reserve. Schedule VI of the Companies Act, 1956, in Part I thereof sets out the form of balance-sheet and its contents which the company is required to prepare and Part II thereof sets out the form of profit and loss account and its requirements and Part III is the interpretation clause setting out the definitions of various expressions, of course, for the purpose of Part I and Part II of the said Schedule. Both the expression 'provision' and 'reserve' have been defined in Part III. Clause 7(1)(a) of Part III defines the expression 'provision' thus :

'the expression 'provision' shall, subject to sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.'

Clause 7(1)(b) defines the expression 'reserve' thus :

'the expression 'reserve' shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability;'.

8. It will thus appear clear that the definitions of the two expressions at least for the purposes of Part I and Part II of the Schedule are mutually exclusive and it is clear that if any amount is retained by way of providing for 'any known liability of which the amount cannot be determined with substantial accuracy', the same will have to be regarded as 'provision' and consequently if any amount is retained which is not designated by way of providing for any known liability the same could be regarded as 'reserve'. The Supreme Court in the case of Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC has explained the distinction between the two concepts as is fairly well known in commercial accountancy thus :

'The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the P. & L. account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest (See Spicer and Pegler's Book-Keeping and Accounts, 15th edition, page 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision : (See William Pickles Accountancy, second edition, page 192; Part III, clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve).'

9. It will thus appear clear that where an amount is set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy, the same is a provision, but if the amount so set aside is not designed to meet a liability, contingency, commitment of diminution in value of assets known to exist at the date of balance-sheet, it will be a reserve. If the test as indicated above is applied to the item of Rs. 22,75,000 being the provision for taxation, it will be clear that this setting aside of the amount from out of the gross profits of the company will have to be regarded as a provision and not a reserve. It cannot be disputed that the relevant previous year in the instant case was the calendar year which ended on 31st December, 1962. Under rule 1 of the Second Schedule to the Super Profits Tax Act the first day of the previous year would be 1st January, 1962, and, therefore, the balance-sheet of the assessee-company as on December 31, 1961, and the profit and loss account for the year which ended on December 31, 1961, would be relevant. It cannot be disputed that on the expiry of December 31, 1961, the assessee-company incurred the taxation liability in respect of the profits which it had earned during that year, though the exact amount of such liability could not be determined with substantial accuracy at that time and the same would have to be ascertained by reference to rates of taxes applicable to that year. The liability for taxation having thus arisen on the expiry of the last day of the year, the setting apart of the sum of Rs. 22,75,000 by the board of directors, will have to be regarded as a provision made for a known and existing liability, the quantification whereof had to be done later. On principle, therefore, it seems to us clear that the item of Rs. 22,75,000 which had been set apart by the board of directors as and by way of provision for taxation cannot be regarded as a reserve.

10. Even on decided cases the point seems to be covered by the view expressed by the Supreme Court in the case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax : [1966]59ITR767(SC) . In that case the Supreme Court was considering the question as to whether a certain amount which had been set apart as provision for payment of income-tax and super-tax was a 'debt owed' within the meaning of section 2(m) of the Wealth-tax Act, 1957, as on March 31, 1957, which was the valuation date, and as such was deductible in computing the net wealth of the appellant-company. It appears that in its balance-sheet for the year ending on 31st March, 1957, the appellant-company (assessee-company) had shown a certain amount as a provision for payment of income-tax and super-tax in respect of that year of account and the Supreme Court took the view that the expression 'debt owed' within the meaning of section 2(m) of the Wealth-tax Act, 1957, could be defined as the liability to pay in praesenti or in futuro an ascertainable sum of money and that a liability to pay income-tax was a present liability though the tax became payable after it was quantified in accordance with ascertainable data; that there was a perfected debt at any rate on the last day of the accounting year and not a contingent liability. The rate was always easily ascertainable. If the Finance Act was passed, it was the rate fixed by that Act; if the Finance Act was not yet passed, it was the rate proposed in the Finance Bill pending before Parliament or the rate in force in the preceding year, whichever was more favourable to the assessee. All the ingredients of a 'debt' were present and that it was a present liability of an ascertainable amount and that, therefore, the amount of the provision for payment of income-tax and super tax in respect of the year of account ending 31st March, 1957, was a 'debt owed' within the meaning of section 2(m) on the valuation date, viz., 31st March, 1957, and was as such deductible in computing the net wealth. In the instant case also the liability to pay tax had arisen on the expiry of December 31, 1961, only its quantum had to be ascertained later and, therefore, the setting apart of the sum of Rs. 22,75,000 by the board of directors must be held to be a provision made by it to meet a known and existing liability.

11. Having regard to the above discussion, we are clearly of the view that the taxing authorities as well as the Tribunal were right in taking the view following the decision of the Supreme Court in Kesoram Industries & Cotton Mills Ltd. v. Commissioner of Wealth-tax : [1966]59ITR767(SC) that the provision for taxation in the sum of Rs. 22,75,000 that was made by the board of directors in the instant case was not a reserve but a provision and as such was not liable to be included in the capital computation of the assessee-company under the Super Profits Tax Act, 1963.

12. Turning to the other item of Rs. 11,83,050 being the amount of 'proposed dividends', rival contentions were urged before us by Mr. Joshi appearing for the revenue and by Mr. Dwarkadas appearing for the assessee-company. Mr. Joshi for the revenue strongly relied upon the decision of the Supreme Court in Commissioner of Income-tax v. Century Spinning and . : [1953]24ITR499(SC) in support of his contention that this item of proposed dividends cannot be regarded as a 'reserve' and the Tribunal was in error in directing its inclusion in the computation of the capital. On the other hand, Mr. Dwarkadas contended that this item representing the proposed dividends had been rightly regarded as a reserve and, therefore, includible in the capital computation under the Super Profits Tax Act, 1963.

13. Relying upon the distinction between a provision and a reserve in commercial accountancy as has been explained by the Supreme Court in Metal Box Co.'s case : (1969)ILLJ785SC , Mr. Dwarkadas contended that this amount which has been set aside or set apart from out of the profits and other surpluses of the assessee-company was not designed to meet a liability, contingency or commitment known to exist at the date of the balance-sheet, for, according to him, neither at the end of the relevant year, viz., December 31, 1961, nor on the crucial date, viz., January 1, 1962, had the liability to pay dividends to the shareholders of the assessee-company arisen and all that the directors of the assessee-company had shown in its profit and loss account for the relevant year and the balance-sheet as on December 31, 1961, was that a sum of Rs. 11,83,050 was shown as the amount of dividend proposed to be distributed for that year, but that until the company in its general meeting accepted the recommendation of the directors and declared the dividend, the directors' report in that behalf will have to be regarded as merely a recommendation which might be modified or even withdrawn and, therefore, as on the crucial date nothing had happened beyond mere recommendation by the directors as to the amount that might be distributed as dividend; in other words, according to him, the liability to pay dividend was to arise only when the shareholders at their general meeting would be passing the necessary resolution after accepting the recommendation of the board of directors. According to him, therefore, the appropriation or setting aside of this amount of Rs. 11,83,050 was not a provision but a reserve for it was not designed to meet any known or existing liability, contingency or commitment. In support of his contention he placed strong reliance upon the observations of the Supreme Court in Metal Box Co.'s case : (1969)ILLJ785SC , where distinction between provision and reserve has been clearly indicated, and also upon the decision of the Supreme Court in Kesoram Industries' case : [1966]59ITR767(SC) . He pointed out that for the purpose of the Wealth-tax Act one of the items which the Supreme Court was considering in that case was the item shown in the profit and loss account as the amount of dividend proposed to be distributed for that year and whether the same could be regarded as a 'debt owed' by the company on the relevant valuation date and as such deductible in computing the net wealth of the appellant-company and he pointed out that the Supreme Court has taken the view that the item of Rs. 15,29,855 which had been shown by the directors of the assessee-company in its profit and loss account for the year ending 31st March, 1957, as the amount of dividend proposed to be distributed for that year was not a debt owed by the company on the valuation date and was not deductible in computing the net wealth of the assessee-company. He pointed out that this decision was based upon the view that as on the valuation date nothing had happened beyond a mere recommendation by the directors as to the amount that might be distributed as dividend there was no debt owed by the company to the shareholders on that date.

14. On the other hand, Mr. Joshi appearing for the revenue has contended that earmarking of a portion of profits by the directors of the assessee-company specifically for the purpose of distribution of dividend will have to be regarded as an act on the part of the directors clearly showing that setting apart of that amount was not as and by way of a reserve. In fact, according to him, such conduct on the part of the board of directors itself took the setting apart of the amount out of the category of 'reserve' and the same will have to be regarded as a provision not liable to be included in the capital computation. In that behalf he placed strong reliance upon the decision of the Supreme Court in Century Mills' case : [1953]24ITR499(SC) and a number of other decisions which have taken a similar view following the Supreme Court decision in Century Mills' case : [1953]24ITR499(SC) ,

15. It would, therefore, be necessary to consider the Supreme Court decision in Century Mills' case : [1953]24ITR499(SC) in some detail and to find out the ratio of that decision. In that case, the material facts were these : For the year ending 31st December, 1945, the profit of the assessee-company, whose accounting year was the calendar year, was a certain sum according to the profit and loss account. After making provision for depreciation and taxation, the balance of Rs. 5,08,637 was carried to the balance-sheet. This sum was not allowed in computing the profits of the assessee for purposes of income-tax. In February, 1946, the directors recommended that out of that amount a sum of Rs. 4,92,426 should be distributed as dividend and the balance of Rs. 16,211 was to be carried forward to the next year's account. This recommendation was accepted by the shareholders in their meeting on 3rd April, 1946, and the amount was shortly afterwards distributed as dividend. In computing the capital of the assessee-company on 1st April, 1946, under the Business Profits Tax Act, 1947, the assessee claimed that the sum of Rs. 5,08,637 and the profit earned by it during the period 1st January, 1946, to 1st April, 1946, should be treated as 'reserves' for the purpose of rule 2(1) of Schedule II. The High Court held that the sum of Rs. 5,08,637 must be treated as a reserve for the purpose of rule 2, but the profit made by the assessee during the period 1st January, 1946, to 1st April, 1946, could not be included in the reserves. On appeal to the Supreme Court, the Supreme Court held that the sum of Rs. 5,08,637 and the profit earned by the assessee during the period 1st January, 1946, to 1st April, 1946, did not constitute reserves within the meaning of rule 2(1) of Schedule II. After noting that the expression 'reserve' had not been defined in the Business Profits Tax Act, 1947, and after noting various dictionary meanings of that expression the Supreme Court observed that what was the true nature and character of the disputed sum (Rs. 5,08,637) was required to be determined with reference to the substance of the matter and looked at from that angle it took the view that as on the crucial date (April 1, 1946) the said sum could not be called a 'reserve' for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. The court pointed out that on 28th February, 1946, the directors clearly earmarked it for distribution as dividend and did not choose to make it a reserve nor did the company in its meeting on 3rd April, 1946, decide that it was a reserve and as such it remained on 1st April, 1946, as a mass of undistributed profits which were available for distribution and not earmarked as 'reserve'. Considerable emphasis was laid by the Supreme Court upon the fact that on 1st January, 1946, the amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The Supreme Court also emphasised the aspect that on 1st April, 1946, which was the commencement of the chargeable accounting period, there was merely a recommendation by the directors that the amount in question should be distributed as dividend, and that this fact, far from showing that the directors had made the amount in question a reserve, showed that they had decided to earmark it for distribution as dividend, and, in fact, by the resolution of the shareholders of 3rd April, 1946, the amount was shortly afterwards distributed as dividend. It would appear clear that the Supreme Court did not approve of the High Court's view that it was open to the directors to distribute the sum of Rs. 5,08,537 as dividend, although it did not choose to do so and had kept back the amount and that, therefore, by keeping back the amount they constituted it a reserve, a view which the Supreme Court regarded as having been expressed under a misapprehension of the real position. The Supreme Court pointed out that the directors had no power to distribute the sum as dividend but they could only recommend, as they indeed did, and it was up to the shareholders of the company to accept that recommendation in which case alone the distribution could take place and since the recommendation was accepted and the dividend was actually distributed, it would not be correct to say that the amount was kept back. The court further held that the nature of the amount which was nothing more than the undistributed profits of the company, remained unaltered, and, therefore, the profits lying unutilised and not specially set apart for any purpose on the crucial date did not constitute reserves within the meaning of Schedule II, rule 2(1). Support for this view was also sought by the Supreme Court by referring to the provision of sections 131(a) and 132 of the Indian Companies Act, and the forms of balance-sheet and profit and loss account as given in Schedule III to the said Act.

16. At this stage it would be convenient to refer to the decision of the Punjab and Haryana High Court in the case of Commissioner of Income-tax v. Hindustan Milk Food Mfg. Ltd. , where Chief Justice Mahajan of the Punjab and Haryana High Court, after analysing the aforesaid decision of the Supreme Court in Century Mills' case : [1953]24ITR499(SC) , has indicated the ratio thereof and the factors which principally weighed with the Supreme Court in arriving at the particular decision which the Supreme Court did. In Hindustan Milk Food Mfg. Ltd.'s case the facts were that in the assessment proceedings for super profits tax for the assessment year 1963-64, the Income-tax Officer had held that the amount of Rs. 8,64,961, being the amount of proposed dividend, was not a reserve includible for the standard deduction for the purpose of rule 1 of Schedule II of the Super Profits Tax Act, 1963.

17. But, in second appeal, the Appellate Tribunal took the view that it was a reserve within the meaning of the said rule, because the assessee had not only earmarked the amount for dividends but had also kept back or set apart or stored up the amount by a definite act as indicated by the profit and loss account and the balance-sheet and had thus been specifically provided to be a reserve for a specific purpose and that the instant case differed from the decision of the Supreme Court in Century Mills' case : [1953]24ITR499(SC) . Before the High Court the decision of the Supreme Court in Century Mills' case : [1953]24ITR499(SC) was relied upon by the counsel for the department as well as for the assessee in support of each one's respective contention. Counsel for the revenue urged that the amount which was provided for dividend could not be a reserve and that this was so held in Century Mills' case : [1953]24ITR499(SC) by the Supreme Court and that it hardly mattered that the amount had been brought from the mass of profit and given a distinct identity, it being under the head 'reserve' in the profit and loss account. On the other hand, counsel for the assessee contended that the moment the amount was brought from the mass of profit and given an identity it automatically became reserve without anything more and in support of this contention reliance was placed upon the Century Mills' case : [1953]24ITR499(SC) . It was in the context of such rival contentions that were urged before the Bench that the Punjab and Haryana High Court analysed the facts which obtained in the Century Mills' case : [1953]24ITR499(SC) as also the factors which weighed with the Supreme Court in coming to a particular conclusion which it did, and, after quoting the relevant passages in extenso, Chief Justice Mahajan has gone on to observe at page 525 of the report as follows :

'It will appear from the above observations that the following matters weighed with their Lordships in holding that the amount of Rs. 5,08,637 was not a reserve, namely :

(1) that the said amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve;

(2) that the reserve could be a general reserve or a specific reserve, but there must be a clear indication to show that it is a reserve of one or the other kind;

(3) the mass of undistributed profits cannot automatically become a reserve;

(4) the mere recommendation by the directors that the amount be distributed as dividend did not shown that the directors had made the amount in question a reserve. But it shows that they had decided to earmark it for distribution as dividend.

18. If these matters are kept in view, it will appear that two things must co-exist before an amount can be treated as a reserve, namely, (a) that the amount must be separated from the general mass of profits, and (b) that it should be apparent from the surrounding circumstances that it is in fact a reserve, and not an amount kept for distribution as dividend. It is not denied, and could not be, that dividend is distributed out of profits. Therefore, to convert the nature of the mass of profits into 'reserve', they cannot be kept apart at the same time for distribution as dividend in the same year. The earmarking of profits has to be with the intention of creating a reserve with a view to distribute them in future lean years as in the case of dividend equalization reserve, and not for distribution of dividend in the same year as in the present case. To my mind the reservation of profits for distribution in the same year as dividend is destructive of making them a reserve. If this distinction is kept in view, the decision of the Supreme Court presents no difficulty, and its ratio becomes clear.'

19. It must be observed that the ratio of the Supreme Court decision as explained by the Punjab and Haryana High Court in the aforesaid case by Chief Justice Mahajan clearly lends support to Mr. Joshi's contention before us that earmarking of a portion of profits by the directors specifically for the purpose of distribution of dividend will have to be regarded as an act on the part of the directors clearly showing that setting apart of that amount was not as and by way of reserve and that such conduct on the part of board of directors itself took the setting apart of the amount out of the category of 'reserve'. It may be noted that the particular ratio in Century Mills' case : [1953]24ITR499(SC) was laid down by the Supreme Court after referring to the legal position which obtains on the point as to when dividend becomes legally payable, for, at page 504 of the report, the Supreme Court has clearly observed that the directors have no power to distribute any sum as dividend, that they can only recommend such distribution and it is upto the shareholders of the company to accept the recommendation in which case alone the distribution can take place.

20. We might next refer to two more decisions of the Supreme Court namely, the decision in the case of First National City Bank v. Commissioner of Income-tax : [1961]42ITR17(SC) and the other in the case of Commissioner of Income-tax v. Standard Vacuum Oil Co. : [1966]59ITR685(SC) , in both of which the court was concerned with the question whether the amount set apart as 'undivided profit' or set apart as 'earned surplus' in accordance with the system of accountancy which obtained in United States amounted to a reserve liable to be included in the capital computation under rule 2 of Schedule II of the Business Profits Tax Act, 1947. The decisions have an important bearing on the issue with which we are concerned especially as the principle of general guidance as to the purpose for which such inclusion in the computation of capital is to be made under the Business Profits Tax Act has been indicated. In both the cases the court was concerned with the assessees who were non-resident companies and followed the system of accounting which obtained in the American commercial world. In the first mentioned case, Justice Kapur, speaking for the court, pointed out the difference between the two systems of accounting in these words - See : [1961]42ITR17(SC) :

'In India at the end of an year of account the unallocated profit or loss is carried forward to the account of the next year, and such unallocated amount gets merged in the account of that year. In the system of accounting in the USA each year's account is self-contained and nothing is carried forward. If after allocating the profits to diverse heads mentioned above any balance remains, it is credited to the 'undivided profits' which become part of the capital fund. If in any year as a result of the allocation there is a loss the accumulated undivided profits of the previous years are drawn up and if that fund is exhausted the banking company draws upon the surplus. In its very nature the undivided profits are accumulation of amounts of residue on hand at the end of the year of successive periods of accounting and these amounts are by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company.'

21. After quoting with approval the above observations of Kapur J. in First National City Bank's case : [1961]42ITR17(SC) , Mr. Justice Shah in Standard Vacuum Oil Co.'s case : [1966]59ITR685(SC) went on to observe as follows :

'It is true that the court in that case was dealing with a case of a banking company. But the characteristics noted are not peculiar to the accounts of a banking company; they are applicable with appropriate variations to the accounts of all companies in which different nomenclatures are used in the accounts to designate the residue on hand as 'surplus', 'undivided profits' or 'earned surplus'.

Where the balance of net profits after allocation to specific reserves and payment of dividend are entered in the account under the caption 'earned surplus', it is intended thereby to designate a fund which is to be utilised for the purpose of the business of the assessee. Such a fund may be regarded according to the Indian practice as 'general reserves'.'

22. The Court in First National City Bank's case : [1961]42ITR17(SC) held that the amount designated as 'undivided profits' which was available for continuous future use for the business of the bank was a part of the reserves and had to be taken into account when computing the capital and reserves within rule 2(1) of Schedule II of the Business Profits Tax Act; similarly, in Standard Vacuum Oil Co.'s case : [1966]59ITR685(SC) , the court held that the amount which had been allocated to 'earned surplus', which was intended for the purpose of business of the assessee-company and was used in subsequent years in business, represented 'reserves' within the meaning of rule 2 of Schedule II of the Business Profits Tax Act. From these two decisions two aspects could be said to emerge very clearly. In the first place, the nomenclature accorded to any particular fund which is set apart from out of the profits would not be material or decisive of the matter and, secondly, having regard to the purpose of rule 2 of Schedule II of the Business Profits Tax Act, 1947, it was clear that if any amount set apart from out of the profits is going to make up capital fund of the assessee and would be available to the assessee for its business purpose, it would become a reserve liable to be included in the capital computation of the assessee for the purpose of the Business Profits Tax Act.

23. Having regard to the above discussion two or three things become at once clear. In the first place, the mass of undistributed profits cannot automatically become a reserve and that somebody possessing the requisite authority must clearly indicate that the amount has been separated from the general mass of profit with a view to constitute it a reserve; secondly, it should be apparent from the surrounding circumstances that the amount so set apart is in fact a reserve to be utilised in future for a specific purpose on specific occasion; thirdly, a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend would be destructive of making that amount a reserve and, lastly, having regard to the purpose of the rules framed for computing the capital of the company for the purpose of super profits tax in the Second Schedule to the Act, the amount so set apart should be available to the assessee for being used in its business. If regard be had to these three or four aspects which emerge very clearly from the discussion of the aforesaid decisions it would appear clearly from the discussion of the aforesaid decisions it would appear clear that the instant case would be almost on all fours with the Century Mills' case : [1953]24ITR499(SC) . The manner in which the directors in their report had indicated the appropriation of the balance of the gross profits after making provision for commission agency, depreciation and tax, namely, that the sum of Rs. 11,83,050, should be appropriated towards payment of proposed final dividend at rates indicated in the report and having regard to the manner in which this particular item had been shown in the balance-sheet as on December 31, 1961, and in the profit and loss account for the year ending December 31, 1961, the amount of Rs. 11,83,050 will have to be regarded as not a reserve and, therefore, the same is not liable to be included in the capital computation under rule 1 of Schedule II to the Super Profits Tax Act,1963.

24. We might indicate here that following the Supreme Court decision in Century Mills' case : [1953]24ITR499(SC) several other High Courts have also taken the view that the amount set apart or appropriated from out of the gross profits for payment of 'proposed dividend' cannot be held to be a reserve and as such is not liable to be included in the capital computation for the purpose of rule 1 of Schedule II to the Super Profits Tax Act, 1963. We may, however, mention that in one of its earlier decisions the Allahabad High Court had taken a contrary view but the same Bench in a subsequent decision has reverted back to the view as propounded by the Supreme Court in Century Mills' case : [1953]24ITR499(SC) . In the case of Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) , the Bench of the Allahabad High Court consisting of R. S. Pathak and H. N. Seth JJ. took a view that the provision for proposed dividend by a company was entitled to be treated as 'reserves' for the purposes of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, and that the same should be included in the computation of capital under that provision where there was no dispute that the said items had actually been debited to the assessee's profit and loss account and had not been allowed as a deduction for the purpose of income-tax assessment. This decision was rendered on 9th August, 1971, and within a few months the same Bench in the case of Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) has taken exactly the contrary view. The court in that case was concerned with four items including the item of 'propos ed dividend' and after referring to the Supreme Court's decision in Century Mills'case : [1953]24ITR499(SC) as well as two later decisions of the Supreme Court in First National City Bank's case : [1961]42ITR17(SC) and Standard Vacuum Oil Co.'s case : [1966]59ITR685(SC) , held that the said four items including the item of proposed dividend cannot represent a reserve and cannot be included in the capital computation under the Super Profits Tax Act, 1963, and the court observed that to constitute a 'reserve' the amount must be specifically kept apart for future use or for a specific occasion. It does appear that the earlier decision in Security Printers of India (P.) Ltd.'s case : [1972]86ITR210(All) was not brought to the notice of the Bench nor has it been discussed by that Bench in its judgment.

25. It may be stated that in the case of Hotz Hotels Pvt. Ltd. v. Commissioner of Income-tax ), the Allahabad decision in Security Printers of India (P.) Ltd.'s case : [1972]86ITR210(All) was not brought to the notice of the Bench nor has it been discussed by that Bench in its judgment It may be stated that in the case of Hotz Hotel Pvt. Ltd. v.Commissionerof Income-tax ,the Allahabad decision in Security Printers of India (P.) Ltd.'s case : [1972]86ITR210(All) has been explained away. In Hotz Hotel's case the question was whether the amount of Rs. 70,000 being the amount set apart for payment of 'proposed dividend' was liable to be treated as a reserve within the meaning of rule 1 of Schedule II to the Super Profits Tax Act, 1963, and the Himachal Pradesh High Court held that the said amount which had been earmarked by the directors for payment of dividends and which recommendation had been approved by the shareholders was not set apart for future use by the assessee and, therefore, the same could not be treated as a reserve. When the court's attention was drawn to the Allahabad High Court's decision in Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) , Chief Justice Pathak explained the said decision by observing thus-See :

'Our attention has been drawn to Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) in which the Allahabad High Court appears to have held that certain sums representing provision for bonus, provision for taxation and provision for proposed dividends were reserves. It is necessary to point out, however, that in taking that view the court specifically observed that it was never the case of the revenue that the amounts represented liabilities which had already arisen and were not intended for future use in a future contingency. It is in that context that the decision in that case has to be appreciated. Sub-sequently, in Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) , the same court held that sums representing proposed dividends and provision for taxation could not be treated as reserves because the material on the record indicated clearly that the amounts had been earmarked, the one for payment of the dividend and the other for the discharge of a tax liability which had already accrued and merely awaited quantification by assessment. The qualitative difference in the material available in the latter case led to a decision different from that in the former case.'

It is unnecessary for us to dilate on this point any further.

26. We may also mention that the Madras High Court in Nagammal Mills Ltd. v. Commissioner of Income-tax : [1974]94ITR387(Mad) as also in United Nilgiri Tea Estates Co. Ltd. v. Commissioner of Income-tax : [1974]96ITR734(Mad) and the Andhra Pradesh High Court in Vazir Sultan Tobacco Co. Ltd. v. Commissioner of Income-tax : [1974]96ITR248(AP) have taken the view that the amount set apart for payment of 'proposed dividends' to the shareholders cannot be regarded as a reserve within the meaning of that expression as occurring in rule 1 of Schedule II to the Super Profits Tax Act, 1963.

27. Two or three decisions which were relied upon by Mr. Dwarkadas in support of his contention may now be referred to. Relying upon the distinction made between 'provision' and 'reserve' by the Supreme Court in Metal Box Co.'s case : (1969)ILLJ785SC , Mr. Dwarkadas contended that, if on principle an amount which had been set apart for the purpose of proposed dividends could not be said to be an amount set aside to provide for any known or existing liability, the same will have to be regarded as a reserve; for, according to the distinction as had been explained by the Supreme Court in that case, any amount which is set aside out of the profits and other surpluses not designed to meet any known or existing liability is reserve and he pointed out that as on the crucial date there being merely a recommendation by the board of directors that certain amount should be spent for payment of proposed dividend and that until the shareholders accepted the said suggestion and passed requisite resolution in their general meeting, the liability to pay dividend cannot be said to arise and, therefore, the amounts so set apart should be regarded as a reserve and not a provision. He pointed out that the principle as enunciated by the Supreme Court in Metal Box Co.'s case : (1969)ILLJ785SC was approved of and followed by the Supreme Court in its subsequent decision in the case of Workmen of William Jacks and Co. Ltd. v. Management of William Jacks and Co. Ltd. : (1971)ILLJ503SC . He also placed strong reliance upon that part of the decision of the Supreme Court in Kesoram Industries' case : [1966]59ITR767(SC) which dealt with the question as to whether the amount which had been set apart as the amount of dividend for distribution for the year was deductible in computing the net wealth of the company as on the relevant valuation date and he pointed out that after accepting the principle that as on the valuation date nothing had happened as to amount that may be distributed as dividend and that the liability to pay dividend did not arise until the company in its general meeting accepted the recommendation of the directors and declared the dividend, the court had gone to hold that there was no debt owed by the company to the shareholders as on the crucial date and, therefore, the same was not deductible from the net wealth of the company. Apparently, there appears to be some force in the contention of Mr. Dwarkadas, but on a closer scrutiny of the three decisions on which reliance was placed it will appear clear that those three decisions were under different enactments and the points which arose for decision were entirely different from the point that has arisen before us under the Super Profits Tax Act, 1963. In the Metal Box Co.'s case : (1969)ILLJ785SC as well as in the case of Workmen of William Jacks and Co.'s case : (1971)ILLJ503SC the question had arisen under the Payment of Bonus Act, 1965, and the question was whether certain sums which had been set apart for payment of gratuity under the gratuity scheme could be legitimately debited in the profit and loss account and whether such appropriation amounted to a reserve or a provision and it was in that context that distinction between 'provision' and 'reserve' was made and the question was considered as to whether the appropriation for the estimated liability under the gratuity scheme, such as the one which the court had before it, was in respect of known and existing liability and as such was deductible from the gross receipts while preparing the profits and loss account. In Kesoram Industries' case : [1966]59ITR767(SC) the question had arisen under the Wealth-tax Act and the question was whether the amount which had been set apart by the directors as an amount proposed to be distributed as dividend had become a 'debt owed' by the company to its shareholders as on the crucial date and the court took the view that the amount of the 'proposed dividends' could not be regarded as a 'debt owed' by the company to the shareholders on that date and as such was not deductible from the net wealth of the assessee-company. In the instant case before us a different question arises under the Super Profits Tax Act, 1963, and the question is whether an amount set apart for the purpose of payment of 'proposed dividends' by the directors falls within the expression 'reserves' occurring in rule 1 of Schedule II to the Super Profits Tax Act, 1963, and that question has to be decided by having regard to the purpose for which the inclusion or exclusion is to be made while computing the capital of the company. The aspect which becomes relevant and almost decisive in the context of the question that has arisen before us it not whether the amount so set apart for the purpose of proposed dividend had become a 'debt owed' by the company to its shareholders but whether the same could be regarded as a reserve - a reserve which could form part of the capital of the company and would be available to the assessee-company for business in future and if this be the aspect which is to be borne in mind with reference to the question to be considered, it is quite clear that if an amount is set apart by the board of directors expressly and avowedly for the purpose of distribution of dividend, then it it obvious that the amount not be available to the assessee-company so as to form its working capital for its future business and, in any case, as has been held by the Supreme Court in Century Mills' case [1953] 24 ITR 799, the directors by recommending what amount should be spent for the purpose of dividend distribution could never have set apart the amount so as to become available to the company in future for its business. In our view, therefore, the aspects which are to be borne in mind while deciding the issue are entirely different from the aspects which were required to be considered under the provisions of the Payment of Bonus Act or under the provisions of the Wealth-tax Act under which the three decisions on which reliance has been placed by Mr. Dwarkadas were decided.

28. Mr. Dwarkadas then contended before us that the decision of the issue then becomes dependent upon whether the sum set apart by the board of directors and recommended by the directors for dividend distribution is actually used for that purpose or not, for, according to him, it is open to the shareholders in their general meeting not only to modify the recommendation of the board of directors but even to reject it in which case the amount though recommended by the board of directors for payment of proposed dividends would form part of reserve which would be available to the assessee for business in future. It may be that different considerations may arise if such a situation occurs. But, in the instant case before us, no material has been placed before us to show that the recommendation of the board of directors had been modified or rejected by the shareholders in their general meeting. On the admitted facts which are available on record it seems to us clear that the directors as on the crucial date had not set apart the amount of Rs. 11,83,050 as and by way of any reserve to become available to the assessee-company for business in future but had in fact by their conduct set it apart avowedly for the purpose of payment of proposed dividends which would be destructive of making it or converting it into a reserve.

29. Having regard to the aforesaid discussion the questions referred to us are answered thus :

Question No. 1 : In the negative, in favour of the department.

Question No. 2 : Affirmative, in favour of the department.

30. Assessee to pay the costs of the reference to the department.


Save Judgments// Add Notes // Store Search Result sets // Organizer Client Files //