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Commissioner of Income-tax Vs. National Rayon Corporation Ltd. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtMumbai High Court
Decided On
Case NumberIncome-tax Reference No. 139 of 1975
Judge
Reported in[1986]160ITR716(Bom)
ActsCompanies (Profits) Surtax Act, 1964; Companies (Profits) Surtax Rules, 1964 - Rule 1
AppellantCommissioner of Income-tax
RespondentNational Rayon Corporation Ltd.
Excerpt:
.....whether certain sums representing debenture redemption reserve includible in computing capital of assessee company under rule 1 - in debenture redemption reserve an amount set aside to meet a future liability which certain to come into existence - it must be regarded as provision and not reserve. (ii) gratuity reserve - whether sums representing gratuity reserve includible in computing capital of assessee company - appropriation of amount towards gratuity reserve is in excess of liability of assessee on account of gratuity determined on an actuarial calculation - in case there is such an excess only to extent of that excess will amount be deemed to be a reserve and includible in computing capital of assessee company under rule 1. - - if a company adopts a scientific method and..........in the balance-sheet of the company for the said two previous years, there was an item of gratuity reserve of rs. 17 lakhs and and an item of debenture redemption reserve of rs. 79 lakhs. we are not quite sure about the correctness of the figure, particularly regarding the debenture redemption reserve, but we are not concerned with whether the said figures are correct. from the balance-sheet, copies whereof have been tendered in the court and by consent taken on record as a supplemental statement of the case, we find that the company had issued secured 6.5 per cent. secured mortgage debentures of the value of rs. 5,90,000 which were redeemable in the period 1965-70 and similar debentures of the value of rs. 2,44,09,000 redeemable in the period 1972-77. it is common ground that.....
Judgment:

Kania, J.

1. This is a reference under section 256(1) of the Income-tax Act, 1961, as applied to the Companies (Profits) Surtax Act, 1964 (referred to hereinafter as 'the Surtax Act'), by section 18 thereof. The assessee is the National Rayon Corporation Limited, a company incorporated under the Companies Act, 1956. The years of assessment with which we are concerned are the assessment years 1966-67 and 1967-68, the relevant previous years being calendar years ended on December 31, 1965, and December 31, 1966, respectively. In the balance-sheet of the company for the said two previous years, there was an item of gratuity reserve of Rs. 17 lakhs and and an item of debenture redemption reserve of Rs. 79 lakhs. We are not quite sure about the correctness of the figure, particularly regarding the debenture redemption reserve, but we are not concerned with whether the said figures are correct. From the balance-sheet, copies whereof have been tendered in the court and by consent taken on record as a supplemental statement of the case, we find that the company had issued secured 6.5 per cent. secured mortgage debentures of the value of Rs. 5,90,000 which were redeemable in the period 1965-70 and similar debentures of the value of Rs. 2,44,09,000 redeemable in the period 1972-77. It is common ground that the company was bound to redeem these debentures during the said periods. In computing the capital of the company for the purposes of determination of standard deduction under the Surtax Act, the Surtax Officer concerned held that these reserves had been created for meeting the specific liabilities and hence were in the nature of provisions and not reserves, with the result that he declined to take them into account in the computation of the capital of the company. On appeals filed by the assessee company against the orders of the Surtax Officer, the Appellate Assistant Commissioner who heard the appeals took the view that the orders of the Surtax Officer were justified in view of the provisions of the Explanation to rule 1 of the Second Schedule to the Surtax Act. The assessee filed appeals in respect of the two assessment years concerned to the Income-tax Appellate Tribunal. The Tribunal observed that under rule 1 of the Second Schedule to the Surtax Act, 'other reserves' made by the company were to be taken into account in computing its capital. Following a decision of the Kerala High Court to which we shall refer later, the Tribunal held that the gratuity reserve and the debenture redemption reserve created by the company could be treated as 'other reserves' within the meaning of the said rule 1 and had to be taken into account in computing the capital base of the company. It is from this decision of the Tribunal that the following question has been referred to us :

'Whether, on the facts and in the circumstances of the case, the sums of Rs. 17,00,000 and Rs. 79,00,000 representing 'gratuity reserve' and 'debenture redemption reserve', respectively, were includible in computing the capital of the assessee company under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'

2. Coming first to the question of gratuity reserve, little scope for argument is left, in view of the leading decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT : [1981]132ITR559(SC) . We have analysed the principles laid down in this decision in some detail in our decision in the case of ClT v. Hindusthan Lever Limited : [1986]160ITR700(Bom) (Income-tax Reference No. 51 of 1975 - decided on September 2, 1985), and hence we do not propose to go through that exercise once again. However, we shall presently set out very shortly what are the principles laid down by the Supreme Court in that case which are applicable to this case. It has been pointed out by the Supreme Court that the word 'reserve' has not been defined in the Super Profits Tax Act, 1963, or the Surtax Act, 1964. The Supreme Court held that the meaning given to the words 'reserves' and 'provisions' in the provisions of the Companies Act, 1956, dealing with the preparation of the balance-sheet and profit and loss account would govern their construction for the purposes of the two enactments. The broad distinction between the two is that whereas a 'provision' is a charge against the profits to be taken into account against gross receipts in the profit and loss account, a 'reserve' is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business. The Supreme Court has further pointed out that if an appropriation of a sum falls within the definition of the term 'provision', it can never be a reserve, but it does not follow that if the retention or appropriation is not a provision, it is automatically a reserve, and that question will have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors, including the intention with which and the purpose for which such retention or appropriation has been made. At page 570 of the aforesaid report, the Supreme Court has set out the definition of the term 'provision' given in clause 7 of Part III of Schedule VI to the Companies Act, 1956. A perusal of that definition shows that the expression 'reserve' means any amount retained or returned by way of providing for depreciation, renewals or diminution in the value of assets or retained by way of providing for any known liability of which the amount cannot be determined with specific accuracy subject to the provisions of sub-clause (2) of clause 7. As far as gratuity reserve is concerned, the Supreme Court has pointed out that ordinarily an appropriation to gratuity reserve will have to be regarded as a provision made for a contingent liability, for, under a scheme framed by a company, the liability to pay gratuity to its employees arises on determination of employment of the employees and has further pointed out that the determination of the employment of an employee is an event which is bound to occur in the service career of every employee. If a company adopts a scientific method and determines the actuarial valuation of the estimated liability of the company in respect of the payment of gratuity in the relevant year and an amount is set apart for meeting such liability, then the amount set apart for that purpose will be clearly a provision. If, however, an ad hoc sum is appropriated for meeting a liability for payment of gratuity without resorting to any scientific basis, such appropriation would also be a provision intended to meet a known liability, though a contingent one, for, the expression 'liability' occurring in clause 7(1)(a) of Part III of the Sixth Schedule to the Companies Act, 1956, includes any expenditure contracted for and arising under a contingent liability; but if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability, it is only the excess that will have to be regarded as a reserve. In the present case, it prima facie appears that amounts have been set apart by an assessee not on any scientific basis but merely ad hoc; and, following the course adopted by the Supreme Court in the aforesaid case of Vazir Sultan Tobacco Co. Ltd. : [1981]132ITR559(SC) , since there is no sufficient material on record to show whether the appropriation made by the assessee towards gratuity reserve was based on any actuarial valuation or was in the nature of an appropriation of an ad hoc amount, we direct that when the matter goes back to the Tribunal, it will decide this question in the light of the principles which we have laid down in this context.

3. We may point out that in respect of the gratuity reserve, the only argument of Mr. Munim, learned counsel for the assessee, was that since in the balance-sheets of the company for the relevant previous years, the amount of gratuity reserve has been treated as 'reserve', it must be regarded as a reserve for the computation of the capital base under the provisions of the Surtax Act. This argument has to be stated to be rejected. As the aforementioned decision of the Supreme Court rightly points out, in order to determine whether any amount is a reserve or a provision, what one must really bear in mind is the true nature and character of the appropriation concerned. The mere fact that it is called a reserve in the balance-sheet of the company can be of very little assistance.

4. We may next come to the item of debenture redemption reserve. Although from the statement of the case, it would appear as if the figure of debenture redemption reserve was Rs. 79,00,000 in both the relevant previous years with which we are concerned, that does not appear to be really so. From the balance-sheets for the said periods, we find that in the calendar year 1965, the development rebate reserve was Rs. 79,00,000. However, in the next calendar year 1966, which is relevant to the assessment year 1967-68, the figure of debenture redemption reserve has gone up to Rs. 1,12,00,000. A perusal of the balance-sheet further shows that the assessee company had floated and actually issued 6.5 per cent. secured redeemable mortgage debentures, as pointed out earlier, against the security of land, buildings and machinery of the company and a floating charge on the undertaking. None of these debentures appear to have been redeemed during the relevant previous years. There is no dispute regarding any of these facts. In these circumstances, it clearly appears to us that the debenture redemption reserve must be regarded as a provision made by the assessee company to enable it to redeem the said debentures when they became due for redemption. Since the aggregate amount of such debentures is much larger than the amount of the debenture redemption reserve, we fail to see how it can be said that there was any excess as such in this appropriation which could be taken as reserve. It is true that all the debentures had not become redeemable during the relevant previous years, but that does not make any difference because an amount set aside to meet a future liability, which was certain to come into existence, as in this case, must be regarded as a provision and not as a reserve.

5. As against this, Mr. Munim placed reliance on the decision of a Division Bench of the Calcutta High Court in CIT v. Placid Limited (Income-tax Reference No. 688 of 1979 - decided on 7th August, 1984). We have permitted Mr. Munim to cite this judgment from these reports but only with some hesitation because, as pointed out by a Division Bench of this court in Commissioner of Sales Tax v. Tirathram Kashmirilal (India) Pvt. Ltd. decided on February 2, 1976, these reports were cited before the Division Bench which noticed that there were a number of inaccuracies, omissions and mistakes in the report when it was compared by the Division Bench with the original judgment. In the case decided by the Calcutta High Court, a sum of Rs 4,41,900 was shown in the balance-sheet of Placid Limited as its capital redemption reserve. It appears that this reserve was to enable the company to redeem certain preference shares which the company had an option to redeem but was not bound to redeem. Even regarding that case, in the judgment, as reported in the aforesaid report, there is some confusion at some places in the report as to whether this amount was for redemption of debentures or redemption of preference shares as aforesaid, but on a perusal of the entire report of the judgment, it is clear that the amount was set apart for redemption of preference shares. In our view, this decision is clearly distinguishable on facts from the case before us. In that case, what the Calcutta High Court had to deal with was a case where an amount was set apart for redeeming preference shares which the company was under no obligation to redeem; whereas, in the case before, us the assessee company was bound to redeem the debentures referred to by us. This decision is, therefore, of no assistance to Mr. Munim in support of his contention.

6. In the result, the question referred to us is answered as follows :

On the facts and in the circumstances of the case, it is directed that when the matter goes back to the Tribunal, the Tribunal will have to determine whether the appropriation of Rs. 17 lakhs towards gratuity reserve is in excess of the liability of the assessee on account of gratuity determined on an actuarial calculation, and if there is such an excess, only to the extent of that excess will the amount be deemed to be a reserve and includible in computing the capital of the assessee company under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and as far as the sum of Rs. 79 lakhs representing debenture redemption reserve is concerned, it will not be includible in computing the capital of the assessee for the aforesaid purpose.

7. The assessee to pay the costs of the reference.


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