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Super Spinning Mills Ltd. Vs. Commissioner of Income-tax - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtAndhra Pradesh High Court
Decided On
Case NumberCase Referred No. 156 of 1976
Judge
Reported in[1979]120ITR512(AP)
ActsCompanies (Profits) Surtax Act, 1964 - Schedule - Rule 1; Income Tax Act, 1961 - Sections 80J and 80K
AppellantSuper Spinning Mills Ltd.
RespondentCommissioner of Income-tax
Appellant AdvocateY.V. Anjaneyulu, Adv. for ;G. Sarangan, Adv.
Respondent AdvocateP. Rama Rao, Adv.
Excerpt:
(i) direct taxation - computation of income - schedule to rule 1 of companies (profits) surtax act, 1964 and sections 80 j and 80 k of income tax act, 1961 - assesse company claimed for purpose of assessment of surtax inclusion in its capital of two sums of rs. 2843984 and rs. 193577 - on first day of accounting year that is on 01.04.1970 aforesaid amounts were shown in balance sheet under 'general reserve' and '80 k tax-free dividend reserve' - whether tribunal was justified in holding that general reserve of assesse company should stand reduced by rs. 400000 - subsequent declaration of dividends from out of general reserve cannot be related back to date of balance sheet - true nature and character of entry in balance sheet is patently one of reserve and not of provision - held, tribunal.....a. sambasiva rao, c.j.1. m/s. super spinning mills ltd., hindupur, is a public limited company. financial year is its accounting year. for the assessment year 1971-72, the assessee-company claimed, for the purpose of assessment of surtax, inclusion in its capital two sums of rs. 28,43,984 and rs. 1,93,577. that was on the basis that on the first day of the accounting year, i.e., on april 1, 1970, the aforesaid amounts were shown in the balance-sheet under 'general reserve' and '80k tax-free dividend reserve', respectively. it was the assessee's claim that in the computation of capital under rule 1 of the second schedule to the companies (profits) surtax act, 1964, these two amounts should be included. the ito declined to do so and excluded the said two amounts from the computation of the.....
Judgment:

A. Sambasiva Rao, C.J.

1. M/s. Super Spinning Mills Ltd., Hindupur, is a public limited company. Financial year is its accounting year. For the assessment year 1971-72, the assessee-company claimed, for the purpose of assessment of surtax, inclusion in its capital two sums of Rs. 28,43,984 and Rs. 1,93,577. That was on the basis that on the first day of the accounting year, i.e., on April 1, 1970, the aforesaid amounts were shown in the balance-sheet under 'general reserve' and '80K tax-free dividend reserve', respectively. It was the assessee's claim that in the computation of capital under Rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, these two amounts should be included. The ITO declined to do so and excluded the said two amounts from the computation of the capital of the company. The AAC in the assessee's appeal upheld its claim in part. He held that the amounts standing in the general reserve account at the beginning of the year was a reserve for the purpose of capital computation. At the same time, he was not prepared to include the total sum of Rs. 28,43,984 shown under the head 'General reserve' in the computation of the capital. Out of this, he excluded a sum of Rs. 4,00,000 which, according to him, was recommended by the directors to be paid as dividends from out of the general reserve and which recommendation was approved at the general body meeting held later. The appellate officer found that the dividends were also paid as proposed by the directors from out of general reserve. In the result, he held that the sum of Rs. 4,00,000 so paid should, therefore, be excluded from the computation of capital, since it was earmarked for payment of dividends and, therefore, only the balance of Rs. 24,43,984 should be treated as reserve to be included in the capital for the purpose of surtax. He also held that the sum of Rs. 1,93,577 shown in the balance-sheet under tax-free dividend reserve was a reserve to be included in the capital. To do this he relied on the decision of the Kerala High Court in CIT v. Periakaramalai Tea & Produce Co. Ltd. : [1973]92ITR65(Ker) .

2. Both the assessee and the revenue carried the matter in appeals to the Tribunal. The revenue objected to the inclusion of Rs. 24,43,984 and Rs. 1,93,577 in the capital computation while the assessee objected to the exclusion of Rs. 4,00,000. The Tribunal upheld the contention of the revenue in regard to the sum of Rs. 4,00,000 and held that only Rs. 24,43,984 out of the general reserve of the assessee-company of Rs. 28,43,984 should be included in the computation of the capital of the company. In doing this, it relied on the principle of relating back laid down by the Supreme Court in CIT v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) . In the view of the Tribunal that principle of relating back would apply to the present case, because though the general reserve was shown in the balance-sheet as on March 31, 1970, at Rs. 28,43,984, the board of directors recommended on 30th of June, 1970, to appropriate Rs. 4,00,000 out of the said amount towards dividends and this recommendation was ratified by the general body of the shareholders later. The Tribunal, therefore, felt that by operation of the principle of relating back, the sum of Rs. 4,00,000 should be deducted from the general reserve of Rs. 28,43,984 shown in the balance-sheet on 31st March, 1970. In so far as the sum of Rs. 1,93,577 representing the '80K tax-free dividend' is concerned, it found that the same was not earmarked for a particular purpose and was not retained to provide for a known liability. It purported to have applied the tests laid down by the Division Bench of this court in Vazir Sultan Tobacco Co. Ltd, v. CIT : [1974]96ITR248(AP) . Then it referred to the Kerala High Court's decision in CIT v. Periakaramalai Tea & Produce Co. Ltd, : [1973]92ITR65(Ker) and felt that the position in regard to '80K tax-free dividend' amount stood on a stronger ground than the retirement gratuity dealt with in the Kerala case and held that the amount formed part of the reserve and so it should be included in the computation of the capital.

3. Thereupon, the Tribunal referred the following question to the High Court at the instance of the assessee :

'Whether, on the facts and in the circumstances of the case, the Tribunal was justified in law in holding that (for purposes of computing capital, under the Companies (Profits) Surtax Act, 1964, for assessment year 1971-72) the general reserve of the assessee-company of Rs. 28,43,984 as on April 1, 1970, should stand reduced by Rs. 4 lakhs, being the dividend declared for year ended March 31, 1970, at the annual general meeting held on 26th August, 1970?'

4. It also referred the following question at the instance of the department :

'Whether, on the facts and in the circumstances of the case, 80K tax-free dividend reserve of Rs. 1,93,577 is eligible for inclusion in the computation of capital under the Companies (Profits) Surtax Act, 1964, for surtax assessment for the assessment year 1971-72 ?'

5. These are the two questions which are to be answered now.

6. In order to answer them, consideration of the material provisions of the C. (P.) S. T. Act, 1964, is necessary. This Act has been enacted for the purpose of imposing ' a special tax on the profits of certain companies'. Section 4 of the Act is the charging provision. It enjoins that there shall be charged on every company, 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. So, surtax is to be levied on the chargeable profits which exceed the permissible statutory deduction. The words 'chargeable profits' are defined in Section 2(5) as:

'......the total income of an assessee computed under the Income-tax Act, 1961 (43 of 1961), for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule.'

7. The words 'statutory deduction' are defined in Section 2(8) as :

'... ...an amount equal to fifteen per cent. (before April 1, 1977, it was 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.'

8. Therefore, the chargeable profits will have to be arrived at for the purpose of levying surtax in accordance with the provisions of the First Schedule to the Act, while statutory deduction will have to be computed in accordance with the provisions of the Second Schedule. That amount or an amount of two hundred thousand rupees, whichever is greater, would be 'statutory deduction'. If the chargeable profits exceeded the statutory deduction, then alone surtax is leviable. If it is within the limit of the statutory deduction, no surtax is leviable under this Act.

9. In this case, we are concerned with statutory deductions. The Second Schedule lays down the rules for computing the capital of a company for the purpose of surtax. Rule 1 thereof says that the capital of a company shall be the aggregate of the amount as on the first day of the previous year relevant to the assessment year, of its paid up share capital and its reserves stated in Clauses (ii) and (iii) of the rule. The Explanation, however, excludes certain items from the category of 'reserves' for the purpose of computation of the capital of a company under the provisions of the Second Schedule. Therefore, for the purpose of assessing a company for levying surtax thereon, its capital shall be computed in accordance with the provisions of the Second Schedule and ten or fifteen per cent. of such capital shall be deducted from its chargeable profits. If ten or fifteen per cent. of the capital is less than two hundred thousand rupees, then an amount of two hundred thousand rupees shall be deducted. It is only the excess amount of the chargeable profits which can be subjected to surtax.

10. In computing the capital of a company, certain reserves are permitted to be included in the amount along with the paid up share capital of the company. These reserves are described in Clauses (ii) and (iii) of Rule 1 of the Second Schedule. We are, in this case, concerned only with the reserves mentioned in Clause (iii). That sub-clause reads thus :

' 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).'

11. The Explanation to that rule declares 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, shall not be regarded as a reserve for the purpose of computation of the capital of a company under the provisions of the Schedule. Therefore, any amount which is entered in the Company's books of account under the items mentioned in the Explanation cannot be regarded as a reserve for computing the capital of the company.

12. In this case, the revenue contends that the two amounts of money mentioned in the two questions referred to the High Court are 'provisions' and not 'reserves', while the assessee maintains that they are other reserves 'within the meaning of Clause (iii) of Rule 1 of the Second Schedule.

13. What is a 'provision' and what is a 'reserve' have been considered at length and in depth by very many decisions of the Supreme Court and the High Courts.

14. Before I refer to the judicial pronouncements, it would be useful to refer to the general instructions for preparing and construing the balance-sheets contained in Schedule VI to the Companies Act of 1956. These instructions would be useful to understand the true nature of the words 'reserve', 'provision' and 'liabilities' since they are not specifically defined in the Surtax Act, 1964.

15. Clause 7(1)(a) of Part 3 of Schedule VI to the Companies Act says that for the purpose of Parts I and II of the said Schedule, the expression 'provision' shall, subject to Sub-clause (2) of the clauses, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. Sub-clause (b) of the same clause says that the expression 'reserve' shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability. Sub-clause (c) states that the expression 'capital reserve' shall not include any amount regarded as free for distribution through the profit and loss account and the expression 'revenue reserve' shall mean any reserve other than a capital reserve. It is further stated that the expression 'liability' shall include all liabilities in respect of expenditure, contracted for and all disputed or contingent liabilities. The provisions of Clause 7 of Part III of Schedule VI to the Companies Act give an indication of the nature and scope of the three expressions 'reserve', 'provision' and 'liability'.

16. I will now very briefly refer to a few rulings. I start with the pronouncements of the Supreme Court in this aspect. In CIT v. Century Spinning and . : [1953]24ITR499(SC) the meaning of the word 'reserve' as used in the Business Profits Tax Act came up for consideration. The Supreme Court laid down that the true nature and character of the disputed sum must be determined with reference to the substance of the matter and that therefore the sum in dispute in that particular case could not be called 'reserve' as on the first day of April, 1946, since 'nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination'. On the other hand, it was pointed out that the directors clearly earmarked the said sum for distribution as dividends.

17. The next case, I would like to refer is Kesoram Industries and Catton Mills Ltd. v. CWT [1966] 59 ITR 167. It arose under the W.T. Act. The directors of the company showed a particular amount as the amount of dividend proposed to be distributed for that year. However, the dividend was actually declared at the general meeting of the company some time later. The question which arose for consideration was whether the amount so set apart by the company as dividend was a 'debt' owed, by the company on the relevant date, i.e., 31st March, 1957. The Supreme Court held that a sum payable upon a contingency does not become a debt until the said contingency has happened.

18. In Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC the question was whether a sum, which was estimated liability under two gratuity schemes and which was deducted from the gross receipts in the profit and loss account, can be deducted while working out the company's net profits for the purpose of the Bonus Act. The learned judges of the Supreme Court referred to Kesoram's case : [1966]59ITR767(SC) and held that in the case before them the question was not whether such estimated liability arising under the gratuity schemes amounted to a debt or not. It was pointed out that the question to be answered was whether the amount allocated towards the said gratuity scheme could be deducted from the net profits for the purpose of the Bonus Act. Then the learned judges proceeded to point out the distinction between 'provision' and 'reserve', It was explained that the provisions made against anticipated losses and contingencies are charges against profits, while 'reserves' are appropriation of profits being retained to form part of the capital employed in the business. It was stated (p. 68) :

'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.'

19. It is also useful to notice the further observation in the case that if under the I.T. Act an estimated liability ascertainable with substantial accuracy can be taken into account for arriving at the true profits and gains, there is no reason why the same under the Bonus Act cannot be done unless there is any provision for bringing the same.

20. Coming to the decisions of the High Courts, the decision of the Kerala High Court in CIT v. Periakaramalai Tea & Produce Co. Ltd. : [1973]92ITR65(Ker) was concerned with the question whether the fund created for payment of retirement gratuity to the employees of a company is a 'reserve' or a 'provision' for the purpose of the Surtax Act. After referring to the various decisions but without taking notice of the Metal Box Company's case : (1969)ILLJ785SC , the learned judges held that the amount in question before them was not for any commitment which had already arisen or commitment of which had fallen due but was only a provision in regard to gratuity which might have to be paid to the employees as and when the liability might arise in future. A Full Bench of this court held in Hyderabad Asbestos Cement Products Ltd. v. CIT : [1976]105ITR822(AP) that this view of the Kerala High Court does not represent the correct position in law.

21. This court considered the question at some length in Vazir Sultan Tobacco Co. Ltd. v. CIT : [1974]96ITR248(AP) . It was a case which arose under the Super Profits Tax Act of 1963, and the question was that the provisions of certain amounts, (1) for taxation, (2) for retirement gratuity, and (3) for dividends, should be considered as 'reserves' within the meaning of Schedule II to the S.P.T. Act, so that they could be considered for determination of the company's capital. The learned judges held that the amount set apart for tax liability was a 'provision' and not a 'reserve' because it was set apart to meet a known liability, the quantum of which, on that date, could not be determined with substantial accuracy and that the amounts retained for gratuity were set apart in respect of liabilities known on the date of the balance-sheet. The learned judges further pointed out that the liability to pay the dividends was existing on the date of the balance-sheet and that the amount which was set apart specifically for the payment of dividends is a 'provision' and not a 'reserve'. It was made clear that the terminology given by the assessee-company to the items is not a decisive factor for deciding the question whether the items constitute 'reserve' or 'provisions'. Since what we are considering in this case is one of dividends, that part of the decision in Vazir Sultan Tobacco's case : [1974]96ITR248(AP) which relates to the amount set apart for dividends is material. There, the directors of the assessee-company had recommended the payment of the amount as dividends. The learned judges proceeded to point out that it had not been shown that the directors had rescinded the recommendation to pay it as dividends. Subsequent events proved that the recommendation of the directors was ratified by the shareholders in which eventuality the shareholders would be entitled to enforce the payment of the dividends against the company. Since the amount had been set apart specifically for the payment of dividends, the learned judges opined that the amount thus set apart was a 'provision' and not a 'reserve'.

22. The correctness of this view of our learned brothers Kuppuswami and Sriramulu JJ. expressed in the aforesaid decision of Vazir Sultan Tobacco's case : [1974]96ITR248(AP) was doubted and consequently another Division Bench referred the problem to a Full Bench. It is in Hyderabad Asbestos Cement Products Ltd. v. CIT : [1976]105ITR822(AP) . The Full Bench of this court resolved the problem. I have already referred to the view of the Full Bench in this case that the decision of the Kerala High Court in Peria-karamalai's case : [1973]92ITR65(Ker) does not represent the correct position of law. The Full Bench also expressed the view that there is no conflict between the decision in Vazir Sultan Tobacco's case : [1974]96ITR248(AP) and that in Kesoram Industries case : [1966]59ITR767(SC) . The problem before the Full Bench arose under the S.P.T. Act and related to the amount set apart for breakages and damages on sales and contingency and bonus. In that particular case these Hems were designated as 'provisions' in the balance-sheet. The question was whether these amounts could be treated as 'reserve' for the purpose of computation of capital. While deciding the question the Full Bench laid down the principles which distinguish a 'provision' from 'reserve'. It was pointed out that a 'provision' does not acquire the character of 'reserve' merely because the assessee has been carrying forward the balance in the provision account from year to year after meeting the liability, unless some person possessing requisite authority designated it as such or indicated the manner of the disposal or the destination of the balance amount concerned. Since no such designation bad been made in the case before them, the learned judges held that the 'provision' could not be treated as a 'reserve' for the purpose of computation of chargeable profits.

23. I may usefully refer to two decisions of the Bombay High Court which throw some light on this problem. The first of them is CIT v. Indian Smelting & Refining Co. Ltd. : [1977]107ITR793(Bom) . It was also a case of computation of capital for the purpose of imposing surtax. The Division Bench held that before dividend is declared at an annual general meeting of the shareholders of the company, there is not even a contingent liability and there is no question of any known OF anticipated liability for which any provisions has to be made. Therefore, where, except for a bare recommendation in the directors' report for declaration of dividend, no amount is set apart during the accounting year for payment of the amount, the liability to pay dividend will arise only from and after the date of the resolution of the shareholders at the annual general meeting declaring the dividend and it would be payable only from such date as may be specified in the resolution. When such dividend is payable out of the general reserve, there is no question of making any provision for the dividend which can be deducted from the general reserve for the purpose of determining the capital of the company under the C. (P.) S.T. Act, 1964. As the liability will arise prospectively it can never relate back to the first, day of the accounting year. While rendering this decision, the Bombay High Court followed the Supreme Court's decision in Metal Box Company's case : (1969)ILLJ785SC .

24. The second Bombay decision is CIT v. Geoffrey Manners & Co. Ltd. : [1977]109ITR172(Bom) . In that case, in the balance-sheet of the assessee-company for the period ended October 31, 1964, under the heading 'Dividend Equalisation Reserve' in the main heading 'Reserve Surplus' as on November 1, 1963, a sum of Rs. 3,40,000 was standing to the credit of dividend reserve. Out of the profits for the period ended October, 31, 1964, a sum of Rs. 5,20,000 was appropriated towards 'dividend reserve account' making a total reserve at Rs. 8,60,000. The directors in their report of May 19, 1965, recommended an aggregate dividend of Rs. 8,00,000 and stated that if the recommendation was approved by the shareholders, it would be paid out of the dividend equalisation reserve and no separate provision had been made therefor. The shareholders later approved of the recommendation to pay Rs. 8,00,000 as dividends. The questions before the High Court were whether the two amounts of Rs. 5,20,000 and Rs. 3,40,000 could be included in the capital or in the income. It was held that the sum of Rs. 3,40,000 out of the dividend equalisation reserve amount was includible in the computation of capital as a 'reserve' as on November 1, 1964, but not the sum of Rs. 5,20,000 transferred to the dividend equalisation reserve during the current year.

25. Lastly I will refer to the Gujarat High Court's decision in CIT v. Mafatlal Chandulal & Co. Ltd. : [1977]107ITR489(Guj) . That, was a case which arose under the S.P.T. Act. The question was whether amounts transferred to 'taxation reserve' and 'proposed dividend' were 'reserves' and could be included in the computation of the capital of the company. It was held that the amount standing in the proposed dividend account was includible in computing the capital of the income. But the amount standing in the 'provision for taxation account' was not so includible.

26. It is not necessary to refer to more decisions since the legal position has been well established by the pronouncements of the Supreme Court and that of this court which are binding on us. The following guiding principles of law for the purpose of deciding what is 'reserve' and what is 'provision' emerge from the above consideration of the case law.

(1) The true nature and character of the disputed sum must be determined with reference to the substance of the matter and not to the mere entry or nomenclature which the assessee-company may choose to give it.

(2) An amount set aside out of profits and other surpluses not 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'.

(3) 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'.

(4) Under the I. T. Act an estimated liability ascertainable with substantial accuracy can be taken into consideration for arriving at the true profits and gains.

27. I will now consider, by applying these principles, whether the two amounts in question can be considered as 'reserves' or 'provisions'. I will first take up the nature of Rs. 4,00,000. The Tribunal rejected the claim of the assessee-company to treat the amount as part of the capital by applying the principle of relating back enunciated by the Supreme Court in CIT v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) . It was pointed out by the Tribunal that though the general reserve was Rs. 28,43,984, in the balance-sheet as on March 31, 1970, the board of directors decided on 30th of June, 1970, to appropriate Rs. 4,00,000 out of the reserve for declaration of dividends. This was later ratified by the general body. The Supreme Court in the Mysore Electrical Industries' case : [1971]80ITR566(SC) held that the decision of the board of directors would relate back to the opening day of the year of account, i.e., April 1, 1970. When that happens, the Tribunal so observed, the general reserve should be reduced by Rs. 4,00,000 from Rs. 28,43,984. In my view, this is a misconception of the legal position. Reading the said Supreme Court's decision with the aid of the Mysore High Court's decision, out of which it arose, it is manifest that the company made five appropriations, (1) for plant modernisation and rehabilitation reserve, (2) loan redemption reserve, (3) reserve for development rebate, (4) dividend reserve, and (3) reserve for super profits tax. The High Court held that the amounts standing to the credit of 'dividend reserve' and 'reserve for super tax' in the balance-sheet of the assessee are in the nature of the items ' provision for taxation' and 'proposed dividends' and consequently they cannot be regarded as 'reserve' for the purpose of computation of the capital. Therefore, the questions relating to the said two appropriations were answered against the assessee. The other appropriations relating to plant modernisation and rehabilitation reserve, loan redemption reserve and development rebate reserve were held to be 'reserves' partaking of the nature of 'capital' Consequently, the revenue preferred the appeal to the Supreme Court in regard to these three items. However, the assessee chose to keep quiet. Consequently, the Supreme Court had to consider only about these three appropriations. The revenue contended that the appropriations having been made on 8th August, 1963, could not be treated as components of capital as on the first day of the previous year, viz., 1st of April, 1963, in terms of Rule 1 to the Second Schedule. It was urged that on 1st April, 1963, these items only formed part of the mass of undistributed profits, no portion of which had teen earmarked or set apart for any particular purpose. Rejecting- 'this view, the Supreme Court observed at pages 569 and 570 :

'It is well known that the accounts of the company have to be made up for a year up to a particular day. In this case that day was the 31st March, 1963. If it was reasonably practicable to make up the accounts up to the 31st March, 1963, and present the same to the directors of the respondent on April 1, 1963, they could have made up their minds on that day and declared their intention of appropriating the said and other sums to reserves of different kinds. But the fact that they could not do so for the simple reason that the calculation and collection of figures of all the items of income and expenditure of the company for the year ending March 31, 1963, was bound to take some time cannot make any difference to the nature or quality of the appropriation of the profits to reserves as determined by the directors after the first of April, 1963, Their determination to appropriate the sums mentioned to the three separate classes of reserves on the 8th August, 1963, must be related to the 1st, of April, 1963, i.e., the beginning of the accounts for the new year and must be treated as effective from that day.'

28. Patently this principle of relating back cannot be applied to the sum of Rs. 4,00,000 in this case. It formed part of the general reserve and there was no indication in the balance-sheet or any designation of the nature of the amount. There was no setting apart of that amount to any particular head.

29. There was no known liability on the date of the commencement of the accounting year for distribution of dividends. In so far as the general reserves are concerned it was not reasonably practicable for the directors to make up the accounts to declare their intention of appropriating the said and other sums of reserves of same kinds. There was no known or ascertainable liability in respect of dividends on the date of the preparation of the balance-sheet. Therefore, the subsequent recommendation of the board of directors to pay dividends to the shareholders to the tune of Rs. 4,00,000 and the subsequent endorsement by the general body of shareholders would not have any effect of dating back the dividends to the date of the preparation of the balance-sheet. Indeed there was no indication of any appropriation in the balance-sheet. In such a case, how could there be relating back to something which was not even in any embryonic form I, therefore, hold that the subsequent declaration of dividends from out of the general reserve cannot be related back to the date of the balance-sheet. The true nature and character of the entry in the balance-sheet is patently one of 'reserve' and not of 'provision'. The amount of general reserve, not to speak of the later declaration of a sum of Rs. 4,00,000 towards dividends from out of the general reserve, was not set apart to meet any liability, contingency, commitment or diminution in value of assets known to exist at the time of the balance-sheet. The board of directors and the general body of the shareholders may or may not declare any dividends. As on the date of the balance-sheet there was no known liability of which the amount cannot be determined with substantial accuracy so that it could be accepted as a 'provision', For these reasons, I hold that for the purpose of computing capital under the C. (P.) S. T. Act, 1964, for the assessment year 1971-72, the general reserve of the assessee-company of Rs. 28,43,984 as on April 1, 1970, shall not stand reduced by Rs. 4,00,000 and that the Tribunal was not justified in holding otherwise. Accordingly, I answer the first question in the negative and in favour of the assessee.

30. Now coming to the other item of Rs. 1,93,577 which was shown in the balance-sheet as '80K tax-free dividend reserve' it has to be noted that this amount represented the tax-free deduction which was available to the company under Section 80J of the I.T. Act. In its balance-sheet, the company showed this amount as '80K tax-free dividend reserve'. The Tribunal held, following the decision of this court in Vazir Sultan Tobacco Company's case : [1974]96ITR248(AP) that this is a reserve which has to be included in the computation of the capital. It based its conclusion on the circumstances that it has not been earmaked for a particular purpose, nor was it a payment in the nature of expenditure, nor was it retained to provide for a known liability, nor was it meant as a provision for depreciation, etc., nor was it allowed as deduction in the computation of income for the purpose of income-tax. This view of the Tribunal appears to me to be correct.

31. As I have already pointed out, this sum of Rs. 1,93,577 was made up of profits which were liable to be deducted from the total income of the company under Section 80J of the I.T. Act as profits arising from a new industrial undertaking. What all the company did in the balance-sheet was only to show it as a separate reserve instead of including it in the general reserve. What the balance-sheet shows is that the said amount was appropriated to '80K tax-free dividend reserve'. It was shown as a separate reserve with the obvious intention of having clear picture of the financial position of the company and if and when any dividends are declared out of the tax-free profits, such dividends would qualify for exemption from tax in the hands of the shareholder under Section 80K of the Act. It is common ground between the revenue and the assessee that this tax-free dividend reserve did not from part of the dividends of Rs. 4,00,000 subsequently declared by the company. An examination of the balance-sheet of the company for the year ended 31st March, 1970, which is material for the purpose of determination of this question, shows that the total net profit for the year including the sum of Rs. 8,907 which was the balance carried down from the previous year was Rs. 20,97,561. The profit and loss account in the balance-sheet shows transfers to general reserve, 80K tax-free dividend reserve, development rebate reserve and provision for taxes, all the sum put together, making up the total of Rs. 20,97,561. These three reserves including the '80K tax-free dividend reserve' were shown in Schedule I to the balance-sheet under 'reserves and surplus' while the provision made for taxes was shown in Schedule IV under the caption 'Current liabilities and provisions'. As against the entries of proposed dividends on preference shares and equity shares, there was blank. That means there was no provision made for these dividends. What is significant is that there is no reference at all to the '80K tax-free dividend reserve' in Schedule IV. Further, in the financial statement there is a five year review of the financial position of the company. One of the items shown in the review is 'dividend for the year', For the year 1970 only, the sum of Rs. 4,00,000 was shown. This must have been prepared subsequent to the preparation of the balance-sheet but it shows that only Rs. 4,00,000 were paid to the shareholders towards dividends and this sum of Rs. 1,93,577 representing '80K tax-free dividend reserve' was not distributed in that year. In the directors' report of 30th of June, 1970, it is seen that the payment of Rs. 4,00,000 was recommended to be paid to the shareholders from the general reserve towards dividends. This shows that there was no recommendation at all by the board of directors to pay this '80K tax-free dividend reserve' to the shareholders in that year. From this, it clearly follows that there was no payment and not even a proposal to pay this amount of Rs. 1,93,577 towards dividends. It is thus clear that it was only for the purpose of clarity and precision that the sum of Rs. 1,93,577 was shown in the balance-sheet arid to make it known that the company had earned this deduction under Section 80J and that the benefit thereof would be available to the shareholders as and when it is ascertained and distributed. Therefore, I am of the opinion that apart from the description of the amount as a 'reserve' and exclusion of it from 'provisions and liabilities' the true nature of the entry relating to this amount in the balance-sheet is only to show it as a separate reserve. It is patent that it was not set aside to meet any liability or contingency or commitment known to exist at the date of the balance-sheet. There was no known liability at the time of the balance-sheet when this reserve was shown. On these considerations, I am inclined to agree with the Tribunal in holding that the amount is eligible for inclusion in the computation of the capital of the company.

32. It is true that the Tribunal has relied, in coming to this conclusion, on the Kerala case (CIT v. Periakaramalai Tea & Produce Co. Ltd. : [1973]92ITR65(Ker) ) which was declared to be bad law by the Full Bench of this court in Hyderabad Asbestos Cement Products Ltd. v. CIT : [1976]105ITR822(AP) . However, it is not necessary to rely on that Kerala decision at all for deciding the nature of the reserve of this amount of Rs. 1,93,577. What I have pointed out clearly shows that it is a 'reserve' and shall be available for computation of the capital of the company under the Surtax Act. I, therefore, answer the second question in the affirmative and in favour of theassessee.

33. In the result, the two questions referred to the High Court are answered as stated above. Having regard to the circumstances of the case, I direct the parties to bear their own costs.

Madhava Rao, J.

I agree.


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