1. The assessee-company claimed certain items as being includible in the computation of its capital for the purpose of Super Profits Tax Act, 1963, for the assessment year 1963-64. These three items were as follows :
Rs.99,723 Doubtful debts reserve.44,12,832 Retirement gratuity reserve.17,00,000 Contingency reserve.
2. In addition to these three items the assessee-company also claimed that an amount of Rs. 1,61,88,099 being the proportionate increase in the capital with effect from May 25, 1962, should also be included in the computation of its capital for the purpose of the S. P. T. Act.
3. In respect of the first three items, i.e., doubtful debts reserve, retirement gratuity reserve and contingency reserve, the ITO held that they represented 'provisions against liabilities' and not reserves. The last item of Rs. 1,61,88,099 which represented the proportionate increase in the capital (220/365) as a result of the issue of bonus shares of the face value of Rs. 2,67,36,000 on May 25, 1962, by converting that much amount out of the reserve into capital, was also rejected for the purpose of includibility in the capital on the ground that the assessee could not be given the benefit of an inflated capital base.
4. This order of the ITO was confirmed by the AAC and the assessee-company, therefore, appealed against the order of the AAC to the Tribunal. The Tribunal held that the first three items were reserves within the meaning of the terms in the Second Schedule to the Act and were, therefore, entitled to be included in the computation of the capital of the assessee-company. With regard to the amounts which were transferred to the contingency reserve, it was argued before the Tribunal on behalf of the assessee that the assessee-company followed the most conservative policy of providing against the remotest possibilities out of abundant caution and as a result Rs. 8,35,000 had been created as a matter of prudence and not because the company really expected any liability to arise in future. With regard to the claim for inclusion of Rs. 1,21,28,044 also the Tribunal held that the assessee was entitled to have that amount included in the computation of the capital of the assessee-company.
5. At the instance of the revenue, the following two questions have been referred to this court under s. 256(1) of the I. T. Act, 1961 :
'(i) Whether, Rs. 99,723, Rs. 44,12,832 and Rs. 17,00,000 were entitled to be included in the computation of the capital of the assessee-company for the purpose of the super profits ta ?'
(2) Whether, Rs. 1,21,28,004 proportionate increase in the capital with effect from May 25, 1962, were entitled to be included in the computation of the capital of the assessee-company for the purpose of the super profits tax ?'
6. Now so far as includibility of the amount of reserve created in respect of bad and doubtful debts and the retirement gratuity reserve is concerned the matter really stands concluded by report decisions and a fresh discussion as to whether for the purpose of the S. P. T. Act, 1963, such amounts should be treated as provision or reserve is not necessary. This court has held in CIT v. Golden Tobacco Co. Ltd. : 108ITR453(Bom) , that doubtful debt reserve account is not intended to provide for 'diminution in value of the assets' nor could it be said that such amount is retained by way of providing for any known or existing liability. This court, therefore, held that the amounts in the doubtful debt reserve account were includible in the computation of the capital of the company for the purpose of the C. (P.) S. T. Act, 1964.
7. In CIT v. Forbes Forbes Campbell & Co. Ltd. : 107ITR38(Bom) this was directly concerned with includibility of the amount by way of gratuity reserve for the purpose of computing capital for surtax purposes and after considering the decision of the Supreme Court in Metal Box Company's case : (1969)ILLJ785SC , it was held that an ad hoc amount set apart and credited to the gratuity reserve without undertaking any actuarial valuation should be regarded as a reserve not being intended to provide for any known or existing liability. While not disputing that the two amounts referred to above had to be included for the purpose of computation of capital, Shri Joshi, appearing on behalf of the revenue, has seriously contended that the contingency reserve in the instant case could not strictly be called a reserve, d because the amounts were set apart for meeting a liability arising out of a possible demand from the excise authorities. In other words, it was contended that the amount of Rs. 8,35,000, which was set aside in order to meet a possible demand for excise duty, could not be a reserve because the liability was anticipated by the assessee-company. The Tribunal while considering the contention of the assessee with regard to the includibility of Rs. 8,35,000 as a reserve, noticed the argument on behalf of the assessee that the assessee-company had purchased some goods but it had no proof with itself to establish that the excise duty had been paid thereon earlier by the vendor and that was why the amount of Rs. 8,35,000 was transferred to the reserve. It was also argued before the Tribunal that the assessee-company did not expect any such claim to be made against it but it was only out of abundant caution that a reserve was created. These arguments were accepted by the Tribunal and the amount was held to be in the nature of reserve. The order of the Tribunal shows that the Tribunal had found as a fact that the excise department had never demanded any duty and that there was no known existing liability of the assessee. The contention which is now raised by Shri Joshi appearing for the revenue assumes that the assessee anticipated a liability and the demand by the excise department to the tune of Rs. 8,35,000. The test to determine whether a particular amount has to be treated as a provision or a reserve is well settled by two decisions of the Supreme Court, viz., Metal Box Company of India's case : (1969)ILLJ785SC and CIT v. Century Spinning and . : 24ITR499(Bom) and a decision of the Calcutta High Court, viz., Duncan Brothers and Co. Ltd. v. CIT : 111ITR885(Cal) . One of the tests is to ascertain whether an amount is designed to meet any liability, contingency, commitment or diminution in the value of the assets known to exist at the date of the balance-sheet. The ratio of these decisions has been extracted by the Calcutta High Court in CIT v. Eyre Smelting Pvt. Ltd. : 118ITR857(Cal) on which the learned counsel appearing on behalf of the revenue heavily relied upon. That was a case in which a provision was made by the assessee in its accounts for bad and doubtful debts under two separate heads, viz., 'Debts outstanding for a period exceeding six months and considered doubtful' and 'Advances recoverable in cash or in kind or value to be received unsecured and considered doubtful'. The contention of the assessee was that the amount of Rs. 1,02,239 which was the aggregate sum of bad and doubtful debts under both the heads should be considered as reserve and included in the computation of capital under the Second Schedule to the S. P. T. Act. 1963. The contention was rejected by the ITO but was upheld by the AAC as well as by the Tribunal. On a reference, however, the Calcutta High Court took the view that a provision was made for an anticipated contingency, for, the item appeared in the profit and loss account and was intended to meet the anticipated diminution of the value of the assets of the assessee, resulting from unrealised debts. The High Court found that the contingency was known and anticipated at the date of the balance-sheet and the amount set apart for the item, though not determined with accuracy, was estimated. It was further found that the amount set apart did not have the characteristics of a reserve but had all the characteristics of a provision because the amount appropriated in the profit and loss account could not be said to form part of the capital employed in the business. On the basis of this authority the learned counsel for the revenue contended that the contingency reserve in the instant case was also made for an anticipated contingency and must, therefore, be considered as a provision and not a reserve. Now, as already pointed out whether a particular item amounts to a reserve or a provision has to be tested on the well-known criteria laid down by the Supreme Court. The characteristics of reserve culled out by the Calcutta High Court in Eyre Smelting Company's case : 118ITR857(Cal) were as follows :
'(a) Reserves are appropriation of profits which are retained to form part of the capital employed in the business.
(b) A reserve is not designed to meet any liability, contingency, commitment or diminution in the value of assets known to exist at the date of the balance-sheet.
(c) A reserve is something set apart for future use or enjoyment.'
8. One of the important considerations which must enter into a discussion of the question whether a particular amount constitutes a reserve or a provision is whether the amount is set apart for a contingency which is 'known to exist at the date of the balance-sheet'. Unless, therefore, the amount of Rs. 8,35,000 can be said to have been set apart for a contingency which was known to exist at the date of the balance-sheet, the said amount could not be termed as a provision. The order of the Tribunal shows that the argument that no duty was required to be paid by the assessee and no duty was ever demanded has been accepted by the Tribunal. This would mean that there was no contingency existing of any possible duty being demanded from the assessee by the excise department. The Tribunal also had accepted the argument that a reserve was created by way of abundant caution. If that argument was accepted it has to be held that the contingency reserve was not intended to provide for any liability known to exist at the date of the balance-sheet. The decision in Eyre Smelting Company's case : 118ITR857(Cal) cannot, therefore, be of any assistance to the revenue. On the finding recorded above the amount of Rs. 8,35,000 must also be treated as a reserve and not as a provision. Similar will be the position in respect of reserve created in respect of Rs. 7,15,300 and Rs. 1,50,000 for meeting a possible liability of sales tax which was not expected to accrue at all and in fact never materialised. In view of the findings recorded the amount of Rs. 17,00,000 was intended to be treated as a reserve.
9. With regard to question No. 2, it is not in dispute that the question has to be answered in the affirmative in view of the decision of this court in CIT v. Geoffrey Manners & Co. Ltd. : 112ITR334(Bom) in which it has been held that it can never be disputed that by the issuance of bonus shares the paid-up capital of the company increased and for the purpose of r. 2 of the Second Schedule to the Surtax Act proportionate increase had to be included in the computation of capital.
10. Accordingly, the questions reproduced are answered as follows :
Question No. 1. In the affirmative and in favour of the assessee.
Question No. 2. In the affirmative and in favour of the assessee.
11. The assessee to get the costs of this reference.