1. In this reference under s. 256(1) of the I.T. Act, 1961, the following question is referred to us for our opinion:
'Whether, on the facts and in the circumstances of the case, the following amounts are includible as 'reserve' within rule 1 of the Second Schedule to the Super Profits Tax Act, 1963 ?
Rs. (1) The provision for bad and doubtful debts 1,05,262
(2) The amount of proposed dividend 40,00,000
(3) The provision of retirement benefits 30,04,497 ?'
2. In this case we are concerned with the assessment year 1963-64, with the accounting year ending on June 30, 1962. The assessee is a limited company. In its return for the assessment year 1963-64 if has included the said three amounts in its capital as reserve for computation of capital under the Supers Profits Tax Act, 1963.
3. As regards item No. 1 namely, Rs. 1,05,262 representing provision for bad and doubtful debts, and item No. 3 namely, Rs. 30,04,497 representing provision for retirement benefit, it is agreed between the learned counsel for the parties that the said amounts having been set apart only on an ad hoc basis, by reason of the decision of this court, they would be considered to be 'reserve' and would be included in the computation of capital. In view of the said agreement, it is not necessary to elaborately discuss this questions as regard the said two items.
4. However, as regards item No. 2, being an amounts of Rs. 40,00,000 set apart as proposed second interim dividend, argument have been advanced at the Bar.
5. The said amount of Rs. 40,00,000 set apart out of profits during the previous accounting year ended on June 30, 1961, represents a gross amount at the rate of 20 per cent. towards a proposed second interim dividend. The directors of the assessee-company at their meeting held on September 8, 1961, to consider the company accounts for the year ending June 30, 1961, had resolved that the a second interim dividend at the rate of 20 per cent. be paid to all the shareholder whose names were on the register of members on September 8, 1961. The said resolution was approved by the shareholders at the annual general meeting held on October 24, 1961. The assessee-company in its return claimed the said amount as reserve and sought to include the same in its capital for the purpose of the Super Profits Tax Act, 1963.
6. The ITO rejected the assessee's said claim, holding the said amount to be a 'provision' and not a 'reserve'. In appeal, the AAC upheld the finding of the ITO. However, the Income-tax Appellate Tribunal, in appeal, held the said amount to be a 'reserve', observing:
'The directors who are competent to recommend the dividend had passed a resolution recommending a transfer from the profits and loss account and according to the ratio of the decision of the Bombay High Court in commissioner of Income-tax v. Aryodaya Ginning & M/g. Co. Ltd. : 31ITR145(Bom) , it would relate back to 30-6-1961. When the shareholder accepted the recommendation, the shareholder becomes entitled to the dividend as from the dated of declaration. This liability can be related back to any earlier dated. As on 1-7-1961, with the directors setting apart the amount of Rs. 40,00,000 it was not a mere mass of undistributed profits.'
7. It is this finding to the Tribunal that is challenged before us by the Revenue.
8. The nature of the amount set part as a proposed dividend has now been laid down by this court in its decision in the case of Shree Ram Mills Ltd. v. CIT : 108ITR27(Bom) . In that case the Tribunal, reversing the decision of the lower authorities, had held, inter alia, that the dividend reserves of Rs. 11 lakhs, odd, set apart towards the proposed dividend was to be treated as 'reserve' to be included in the computation of capital under the I.T. Act, 1961. Against the said decision, a reference was made to his court. This court reversed the said finding of the Tribunal. The court, after referring or various decision cited across the Bar, held (headnote):
'As regards the amount of Rs. 11 lakhs odd, being the amount of the proposed dividends, in the first places, a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that the amount has been separated from the general mass of profits 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 further for a specific purposes on a specific occasion; thirdly, clear conduct on the part of the directions 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 son the rule framed for computing the capital of the company for the purposes of super profits tax in the Second Schedule to the Act, the amounts so set part should be available to the assessee for being used in its business. 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, viz., that Rs. 11 lakhs odd should be appropriated towards payment of proposed final dividend at the rate indicated in the report and having regard to the manner in which this particular item has been shown in the balance-sheet as on December 31, 1961, and in the profits and loss account for the year ended December 31, 1961, the amount of Rs. 11 lakhs odd will have to be regarded as not a 'reserve' and, therefore, the some is not liable to the included in the capital commutation under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.'
9. In this case there is no dispute that the directors of the assessee-company at their meeting held on September 8, 1961, to consider the accounts of the company for the year ended June 30, 1961, had passed a resolution for granting a second interim dividend at 20 per cent to those shareholder whose names were on the register of members on that day. The said resolution was approved at the general body meeting of the shareholder held on October 24, 1961. A copy of the directors said resolution at their meeting held on September 8, 1961, produced by the learned counsel for the assessee shows that it was to declare a second interim dividend at 20 per cent, less tax, in respect of the year ended on June 30, 1961, to be paid to all shareholder whose names appeared on the register of members of September 8, 1961. The said amount of Rs. 40,00,000 was also show in Sch. II to the company balance-sheets on June 30, 1961, as a second interim dividend along with the first interim dividend that the declared on 5th April, 1961.
10. The fact mentioned above, in our view, comply with the test laid down in the afore cited decision of this court in Shree Ram Mills, case : 108ITR27(Bom) , to hold that the said amount was a 'provision'. As observed therein, the said amount of Rs. 40,00,000, set apart towards the proposed second interim dividend, was separated from the general mass of profits by the resolution dated on September 8, 1961, of the board of directors who were competent to do so and that the conduct of the directors manifested by the said resolution in setting apart the said amount from the mass of undistributed profits for the purpose of distribution of dividend was destructive of the said amount being reserve and that the said amount could no be thereafter available to the company for being used in its business. So also the directors have in balance-sheet of the company as on June 30, 1961, indicated that after making a provision for liability, the said amount of Rs. 40,00,000 from the gross profits should be appropriated towards the payment of the proposed dividend. Under the circumstances, therefore, the said proposed interim dividend could not be considered as 'reserve'.
11. The learned counsel for the assessee contended that since the laws did not required any resolution to be passed for the declaration of interim dividend in this case, the company liability to pay such dividend would accuse only when the shareholder at the general body meeting approved of such dividend being given, which was on October 24, 1961, and, therefore, the declaration of the dividend would not related back to June 30, 1961, that is, the end of the accounting year. The learned counsel for the assessee further contended the t as the said interim dividend did not pertain to the profits of the company as they stood during the relevant accounting year ended on June 30, 1961, the said amounts should be considered as 'reserve' while computing the capital of the company as on June 30, 1961.
12. In our view, the said contentions of the learned course for the assessee cannot be accepted. The directors said resolution in terms provides for the said second interim dividend, being in respect of the year ended on June 30, 1961, making it clear that the said dividend was in respect of the profits earned during the accounting year. That also is made clear in the balance-sheet of the company as on June 30, 1961. In that regard, the fact that the directors resolution proposing the declaration of the interim dividend and shareholder approval to the same were passed and given subsequently, that is, on September 8, 1961, and October 24, 1961, respectively, would not make any difference to the matter as the said resolution and approval would relate back to 30th June, 1961.
13. In that view of the matter, we are unable to accept the said finding of the Tribunal as regards the said amount of Rs. 40,00,000 set apart by the company for the second interim dividend, being a reserve. In our view, the said amount cannot be treated as 'reserve' but could be treated only as 'provision' for the purpose of the Super Profits Tax Act, 1963.
14. Accordingly, we answer the question as follows :
As regard items Nos. 1 and 3, the answer would be in the affirmative and in favour of the assessee.
15. However, as regard item No. 2, being the amount of Rs. 40,00,000 set apart towards the proposed second interim dividend, the answer would be in the negative and against the assessee.
16. In the circumstances, as both the parties succeed partially, in parties to bear their own costs.