1. In this reference the question referred to the High Court under s. 256(1) of the I.T. Act, 1961, is as follows :
'Whether, on the facts and in the circumstances of the case, all or any of the four funds set out in para. 1 above was liable to be included in the computation of the capital of the company under the Second Schedule to the Act for the purpose of determining the standard deduction under section 2(9) of the Super Profits Tax Act, 1963 ?
The assessee-company is the Gokak Mills Ltd. The four funds, with which we are concerned in this reference, which are enumerated in the statement of the case, are as follows : Rs.'(a) Provision for staff gratuity 1,62,917(b) Provision for contingencies 74,930(c) Provision for freight, rebate, etc 48,388(d) Proposed dividend 11,88,579------------14,74,814'-----------
2. The question very briefly paraphrased would be whether the four amounts or funds were reserves and liable to be included in the computation of the capital of the company. As far as items (a) and
(d) are concerned, the question would seem to be concluded by decisions of the Bombay High Court, and we propose to answer them in accordance with the said decisions. As far as items (b) and (c) are concerned, the principles now are well settled (as far as the Bombay High Court is concerned), and the application of the principles presents very little difficulty in the instant case. Thus, an elaborate recital of the facts or statement of law appears to be unnecessary.
3. Item (a) is a provision for staff gratuity. According to the Tribunal the funds in question were set apart not because there was any existing liability, and they had been set apart even when no liability whatsoever existed or even when the liability was so slender and distant that no prudent and reasonable person would have thought of providing against the same. In other words, this was just an ad hoc setting aside and not any setting aside for a known, existing or properly computed liability.
4. This question has been duly considered in CIT v. Forbes Forbes Campbell & Co. Ltd. : 107ITR38(Bom) . It has been observed by Tulzapurkar J., speaking for the Bench of this High Court, as follows (p. 44) :
'In the absence of any actuarial valuation having been undertaken and also in the absence of setting apart the amounts without there being any gratuity scheme having been framed and got approved by the company, the amounts so set apart will have to be regarded as making a provision for contingent liability the present discounted value whereof had not been ascertained. In the circumstances, we are of the view that these three items which were found credited in the gratuity reserve will have to be regarded as amounts retained not intended to provide for any known or existing liability and as such these will have to be regarded as reserves.'
5. The said propositions will be equally applicable to the present case. Thus, as far as this provision is concerned, it will have to be held to be a reserve liable to be included in the computation of the capital of the company for the purpose of determining the standard deduction under s. 2(9) of the S.P.T. Act, 1963. The answer is accordingly in favour of the assessee and against the revenue.
6. As far as item (d) is concerned, the argument advanced on behalf of the assessee, which found favour with the Tribunal, was that this was a fund set apart as proposed dividend and till the annual general meeting took place, which was yet to take place, the company was under no legal liability to pay the same. Accordingly, it was contended by the assessee that the fund possessed all the characteristics of a reserve. It was urged on behalf of the revenue before the Tribunal that this was a provision created for a special purpose and that the dividend was a liability even before the resolution to pay the same was passed at the annual general meeting. The Tribunal held in favour of the assessee, but it would appear that a Division Bench of this court in CIT v. Bharat Bijlee Ltd. : 107ITR30(Bom) , has taken a view which accepts the contention of the revenue. In Bharat Bijlee's case : 107ITR30(Bom) the directors appropriated a sum of Rs. 4,35,000 to be credited to the dividend reserve account which raised the aggregate amount in the said account to Rs. 5,90,000. The directors had recommended for the year ended 30th June, 1964, an aggregate amount of dividend of Rs. 2,30,000. No independent provision was made for payment of this amount, but it was stated that it would be paid out of the dividend reserve. The Bench held that Rs. 2,30,000 was to be considered as a provision and only Rs. 3,60,000 as a reserve, includible in the computation of the capital of the assessee company as on 1st July, 1964. Kantawala C.J. speaking for the Bench, observed (p. 35) :
'From the commercial point of view if any amount is required for incurring any expenditure or making any disbursements in a current year, then ordinarily the same will come out of the income of the company if it is available and only if it is insufficient then the past savings will be resorted to for the purpose of incurring the expenditure or making disbursements. In the present case there is no doubt that, ordinarily, if the current profits are sufficiently available, then the same will be utilised for the purpose of payment of the dividend and, looked at from that point of view, the sum of Rs. 2,30,000 should be regarded as having been paid out of the sum of Rs. 4,35,000. The aggregate amount thus standing to the credit of the dividend reserve account would be Rs. 3,60,000 after payment of the dividend amount of Rs. 2,30,000.'
7. Accordingly, in our opinion, as far as item (d) is concerned, it will have to be held that the said amount of Rs. 11,88,579 was not liable to be included in the computation of the capital of the company under Sch. II to the I.T. Act, 1961, for the purpose of determining the standard deduction under s. 2(9) of the S.P.T. Act, 1963. As far as this item is concerned, the question is answered in favour of the revenue and against the assessee.
8. As far as items (b) and (c) are concerned, namely, the provision for contingencies in the amount of Rs. 74,930 and the provision for freight, rebate, etc., in the amount of Rs. 48,388, we have to note the findings of the Income-tax Appellate Tribunal which are to the effect that the funds in question were not set apart because there was any existing liability or the possibility of a liability arising in future. According to the Tribunal, these two funds had been set apart even when no liability whatsoever existed or even when the liability was so slender and distant that no prudent or reasonable person would have taken note of the same or would have thought of providing against the same. Once these findings are accepted, and they have to be accepted, it would appear that the answers to these questions are also concluded by the principles enunciated by a Division Bench of this court in CIT v. Century Spg. & Mfg. Co. Ltd. : 108ITR431(Bom) . In the said case, the Division Bench was considering a sum shown as provision for contingencies. On a scrutiny of the factual position it was found that the provision for contingencies made by the assessee was not for an existing liability. The Division Bench followed the principles laid down by the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , where it was observed that an amount set aside out of the profits or 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 would be a reserve. Applying the principles enunciated in Century Spg. & Mfg. Co's case : 108ITR431(Bom) as also the principles enunciated by the Supreme Court in Metal Box Company's case : (1969)ILLJ785SC , it would appear that the view taken by the Income-tax Appellate Tribunal regarding items (b) and (c) is correct and these two funds were liable to the included in the computation of the capital of the company under Sch. II to the S.P.T. Act, 1963, for the purpose of determining the standard deduction under s. 2(9) of the S.P.T. Act, 1963. In other words, as far as these two funds are concerned, the question is answered in the affirmative and in favour of the assessee.
9. To summarise, as far as the items (a), (b) and (c) are concerned, the question referred to us is answered in the affirmative and in favour of the assessee. However, as far as item (d) for proposed dividend is concerned, the question is answered in the negative and in favour of the revenue.
10. Since both sides have partly succeeded and partly failed in the reference, they are directed to bear their own costs of the same.