1. The assessee in all these three cases is M/s. Indian Telephone Industries Ltd., Bangalore, and the relevant assessment years are 1966-67, 1967-68 and 1968-69. The common questions in these cases which are referred to us by the Income-tax Appellate Tribunal, Bangalore Bench, Bangalore, under s. 18 of the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as 'the Act'), read with s. 256(1) of the I.T. Act, 1961, are these :
'(i) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the sums representing the subsidy received from the Government for purposes of Industrial Housing constitute 'reserves' within the meaning of rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964
(ii) Whether, on the facts and in the circumstances of the case, the Tribunal is right in law in holding that the sum under the head 'reserves for bad and doubtful debts' constitutes 'reserves' within the meaning of rule 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'
2. It is convenient to answer to second question first. The question is whether the amount shown as 'reserve for bad and doubtful debts' in the balance-sheet of a company can be considered as a 'reserve' within the meaning of r. 1(iii) of the Second Schedule to the Act. It is seen from the order of the Tribunal that the amounts which have been set apart during the relevant years by the assessee under the head 'Reserve for bad and doubtful debts' were not set apart to meet any known liability or contingency on the dates of the balance-sheets. The main contention urged by the departmental representative before the Tribunal on the above question was that such 'reserves' could not be taken into consideration for purposes of computing the capital base for determining the statutory deduction during the relevant years as they were in the nature of 'provisions' and not 'reserves'. Since the sums set apart as 'reserve for bad and doubtful debts' were not in regard to any known liability on the dates of the balance-sheets, we do not find any substance in the contention urged on behalf of the department. The second question has, therefore, to be answered against the department. It is answered accordingly.
3. Few facts have to be stated in order to consider the connotations involved in the first question. During the relevant accounting years, the assessee had received Rs. 2,82,500, Rs. 5,34,666 and Rs. 5,34,666, respectively, from the Government of India by way of subsidy towards the cost of construction of houses for its employees under the Industrial Housing Subsidy. Clause 12 of the said scheme provided thus :
'If the applicant(s) shall become insolvent or go into liquidation or the applicant(s) shall fail to observe or perform any of the terms and conditions herein contained and/or specified in the pamphlet 'Government of India subsidised housing scheme for industrial workers' and on its/their part to be observed and performed then and in such case, the whole of the amount of the subsidy shall become payable forthwith the Government with interest thereon at the rate of 8% per annum calculated from the date of payment by the Government of the subsidy'.
4. In view of the above clause, the assessee showed the amount received by way of subsidy from the Government of India as a 'reserve' in its balance-sheet since the amount received by way of subsidy was liable to be payable forthwith to the Government of India in the event of any of the events mentioned therein taking place. The balance-sheets were approved at the meeting of the company. During the relevant assessment years, the assessee claimed that the subsidy received by its shown as 'reserves' in the relevant balance-sheet should also be taken into consideration as forming part of the capital base for determining the statutory deduction admissible under the provisions of the Act. It has to be mentioned here that the charging section under the Act, i.e., s. 4, provides that subject to the provisions contained in the Act, there shall be a charge for every assessment year commencing on and from the 1st day of April, 1964, a tax (in the Act referred to as the surtax) in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third Schedule of the Act. Chargeable profits are defined in sub-s. (2) of s. 5 of the Act as the total income of an assessee computed under the I. T. Act, 1961, for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule of the Act. The expression 'statutory deduction' is defined in s. 2(8) of the Act as an amount equal to ten per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of two hundred thousand rupees, whichever is greater. It becomes clear from a combined reading of s. 4 and sub-ss. (5) and (8) of s. 2 of the Act, the liability to surtax would get diminished as the capital base computed in accordance with the Second Schedule of the Act increases. Rule 1 of the Second Schedule of the Act provides that 'subject to the provisions contained in that Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of -
(i) its paid-up share capital;
(ii) its reserves, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922 (11 of 1922), or under sub-section (3) of section 34 of the Income-tax Act, 1961 (43 of 1961);
(iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961);... Explanation. -For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the heading 'RESERVES AND SURPLUS' or of any item under the heading 'CURRENT LIABILITIES AND PROVISIONS' in the column relating to 'Liabilities' in the 'Form of Balance-sheet' given in Part I of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule'.
5. The Tribunal has held that the amounts in question which had been shown as 'reserves' came within r. 1 (iii) of the Second Schedule and directed the inclusion of the said amounts in the capital base for purposes of levy of surtax. Aggrieved by the said finding of the Tribunal, the department requested it to refer the first question for the opinion of this court. That is how the above question arises for consideration in all these three cases.
6. It was argued by Sri S. R. Rajasekharamurthy, learned counsel for the department, that in order to claim the benefit under r. 1(iii) of the Second Schedule of the Act, the assessee should show that the 'reserves' in question had been created by it from out of the profits earned by its an since admittedly the amounts in question were subsidies given by the Government of India, they could not be treated as 'reserves' entitling it to claim their inclusion in the capital base for purposes of determining statutory deduction under the Act. In Metal Box Co. of India Ltd. v. Their Workmen : (1969)ILLJ785SC , the Supreme Court had occasion to deal with the nature of a 'reserve' found in the balance-sheet of a company. At page 67 of that decision, Shelat J. observed as follows :
'The next question is whether the amount so provided is a provision or a reserve. The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made a 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 aad reserve funds are shown as part of the proprietor's interest (See Spicer and Pegler's Book-keeping and Accounts, 15 the 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 p. 192; part III, clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve)'.
7. It is seen from the above observation of the Supreme Court that a reserve need not always be created out of profits and it can be created out of other surpluses also. We, therefore, find it difficult to agree with he submission made on behalf of the department that the amounts in question which did not form part of the parts of the assessee could not be considered as 'reserves'. The expression 'reserve' is not defined in the Act. It has, therefore, to be understood in the manner in which it is used in commercial practice. As observed by the Supreme Court, it is an amount which is set apart to meet a contingency, which is not known at the time when the balance-sheet is prepared. In the instant case, as already observed, the subsidy received by the assessee has to be utilised for the construction of houses of workers and such utilisation it becomes part of the assets of the assessee. The question of repayment would arise only when the assessee goes into liquidation or when the conditions of grant are violated. These are unknown factors on the date of the preparation of the balance-sheet. They cannot, therefore, partake of the character of provisions.
8. It is next argued by Sri. S. R. Rajasekharamurthy, that if the amounts in question are treated as surpluses and not part of profits, then the same would get excluded from the capital base by virtue of the Explanation to r. 1 of the Second Schedule of the Act which provides, inter alia, that any amount falling under item 5 in Sch. VI of the Companies Act under the heading 'Reserves and Surplus' should not be taken into consideration for determining the capital base under the Second Schedule of the Act. There is not much force in this contention. Item 5 of Schedule VI of the Companies Act under the heading 'Reserves and Surplus' reads :
'Surplus, i.e., balance in profit and loss account after providing for proposed allocations, namely-dividend, bonus or reserves'.
9. The surplus referred to in item 5 is the surplus which remains over after the allocation of the reserves. In these cases, the subsidies in question have been allocated in the balance-sheets as reserves and hence the Explanation to r. 1 of the Second Schedule of the Act is of no avail to the department. It appears to us that the amounts in question fall under item 4 of Sch. VI of the Companies Act under the head 'Reserves and Surplus' which reads :
'Other reserves specifying the nature of each reserve and the amount in respect thereof'.
10. The Tribunal was, therefore, right in holding that the amounts in question fall under clause (iii) of r. 1 of the Second Schedule of the Act which provides for the inclusion of the other reserves as reduced by the amounts credited to such reserves as have been allowed as income of the company for the purposes of tth Indian I. T Act, 1922, or the I. T. Act, 1961, in the capital base for purposes of determining the statutory deduction. We, therefore, answer question No. 1 also against the department.
11. In the result, both the questions are answered in the affirmative. In the circumstances of the case, we direct the parties to bear their own costs.