1. These two appeals are taken - together and disposed of by a common order.
2. The assessee is a limited company. Appeal No. 4 (Cal.) of 1981 arises out of the order of the Commissioner under Section 16(1) of the Companies (Profits) Surtax Act, 1964 ('the Act'). Appeal No. 34 (Cal.) of 1981 arises out of the order of the ITO who re-made the assessment after the order of the Commissioner under Section 16(1) of the Act.
3. The assessee-company filed its return under the Act showing the chargeable profit of Rs. 1,28,87,153 on 30-9-1975. The ITO computed the capital of the company for the purpose of allowing statutory deduction at Rs. 5,87,75,312. He allowed the statutory deduction, at 10 per cent of the above amount, at Rs. 58,77,531. He calculated the gross chargeable profit of Rs. 2,27,17,219 and after deducting the standard deduction of Rs. 58,77,531 determined the net chargeable profit at Rs. 1,68,39,688. The Commissioner perused the record of the ITO and found that the order passed by the ITO was erroneous and prejudicial to the interest of the revenue. He, therefore, issued a notice under Section 16. The Commissioner stated that the ITO in determining the capital base for arriving at the standard deduction for the year included the debenture stock redemption reserve and the full amount standing in the general reserve account. The inclusion of the sum of Rs. 24 lakhs on account of the debenture stock redemption reserve, was erroneous. He further indicated that the full amount of general reserve, as on 1-1-1974, could not have been considered for inclusion, inasmuch as the proposed dividend of Rs. 24,32,250, for the year 1973, was to be paid from the general reserve. Therefore, the inclusion of the amount was also erroneous. The assessee's representative pleaded before the Commissioner that the general reserve was rightly taken so far as the amount of dividend of Rs. 24,32,250 was concerned. However, on the debenture stock redemption reserve, he stated that the debenture stock redemption reserve as appearing in the balance sheet of the company was not hit by any of the provisions of the Explanation to Rule 1 of the Second Schedule of the Act, and that the accumulation, out of the appropriation of the profits for the earlier years, towards this reserve had not been separately invested or separately kept as a fund and further that such accumulation had been part of the total assets of the company and had remained as its current assets and, therefore, the debenture stock redemption reserve is in no way different from the general reserve and, as such, it should rightly be included as part of its capital. It was further stated that after the debenture stock, in respect of which the debenture stock redemption reserve has been created, has been repaid in due time, the debenture stock redemption reserve will have to be transferred to the general reserve. The Commissioner first discussed the history of the debenture issued by the assessee-company and then proceeded to consider the arguments. He first considered whether the debenture stock redemption reserve created by the assessee could be treated as a 'sinking fund'. The conclusion of the Commissioner was against the assessee. He was also not agreeable with the assessee that the debenture stock redemption reserve was a reserve of the assessee. He further found that even a part of the debenture stock redemption reserve was not invested by the assessee.
The Commissioner had discussed three arguments of the assessee -in paragraphs 7 and 8 of his order as follows : 7. One of the questions that arises is whether the debenture stock redemption reserve is in effect a 'sinking fund' as appearing in the form of balance sheet under Schedule VI to the Companies Act, 1956 and whether it is thus coming under Item 7 under the head 'Reserves and Surplus' on the liabilities column (side) of the form of balance sheet. If so, it would be hit by the Explanation to Rule 1 of the Second Schedule of the Companies Profits Surtax Act. However, 'the instructions in accordance with which liabilities should be made out' as given in the form of balance sheet is that the word 'fund' in relation to any 'Reserve' should be used only where such Reserve is specifically represented by earmarked investments. In the present case, there have been no such earmarked investments relating to the debenture stock redemption reserve and in that view of the matter it cannot be treated as a sinking fund.
8. The next question is whether notwithstanding the use of the expression 'Reserve', the amounts to the credit of the Debenture Stock Redemption Reserve constitutes really a Reserve. Part III (the interpretation clauses of Schedule VI of the Companies Act) of Schedule VI of the Companies Act throws some light on the matter.
Rule 7(1)(&) says that the expression 'Reserve' shall not include any amount retained by way of providing for any known liability. The expression 'provision' is defined in Rule 7(1)(a) to mean any amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.
In the circumstances of this case, the provisions of Rs. 6 lakhs out of the profits for the Debenture Stock Redemption Reserve can be said to be a provision towards a known liability arising out of contract. It cannot therefore be treated as 'Reserve' for computing the capital for the purposes of the Surtax Act. The point that the Debenture Stock Redemption Reserve, on re-payment or redeeming the debenture stock would be closed by transfer to the general reserve does not have any special bearing inasmuch as even in a case where there is a Debenture Stock Redemption Reserve Fund or Debenture Stock Sinking Fund, such a Fund will be closed, according to all standard works on accountancy, by transfer to the general reserve.
(The fund account which figures on the assets side will be wiped out along with the Debenture Stock account, which figures on the liabilities side.) Such a Debenture Stock Sinking Fund cannot be treated as part of the Reserve for capital computation in view of the Explanation below Rule 1 of the Second Schedule to the Surtax Act. Besides, whether an earmarked Fund has been created or not, really makes no difference because the income from the Fund as such will form part of the income of the Company, even in a case where the Fund is kept deposited with a Bank inasmuch as the ownership of the Fund continued with the Company.
He, accordingly, came to the conclusion that the order of the IT O was erroneous as the ITO had not reduced the general reserve by Rs. 24,32,250 and Rs. 24,00,000. He, therefore, directed the ITO to exclude these amounts from the computation of capital and modify the assessment accordingly.
4. Shri B.D. Nagpal, the counsel of the assessee, filed a paper book which included the Directors' Reports, Balance Sheet and profit & loss account for the year ended 31-12-1974, Schedules 2 and 3 of the Balance Sheet and extract from Book-Keeping and Accountancy by Spicer and Peigler at pages 270 to 271, 157 to 159 and 356. On the basis of these papers, the assessee's counsel stated that the debenture stock redemption reserve was only a reserve within the meaning of the Act and, therefore, the ITO was correct in not excluding the amount while computing the capital for the purposes of standard deduction. He referred to the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT  132 ITR 559 at page 569, and urged that the Supreme Court had occasion to consider the distinction between a provision and a reserve. If the principle laid down by the Supreme Court is taken into consideration, the debenture stock redemption reserve was only a reserve and it was not a provision. He stated that this reserve has been created not out of the profits and loss account of the assessee but the reserve has been created out of the appropriation account. In this connection, he referred to the directors' report on page I of the paper book as well as the appropriation account appearing on page 3 and also Schedule 2 on page 4 for reserve and surplus. Referring to these pages, the counsel of the assessee stated that it is evidently clear that the debenture stock redemption reserve has been appropriated out of the profit and the reserve has not been created in the profit and loss account. It was stated that, the assessee-company has already issued debentures for which debenture account has been credited and, therefore, the assessee could not have credited the same account by debiting the amount in the profit and loss account. Therefore, the reserve created by the assessee was only out of the surplus profit. The reserve did not create any charge on the profit of the assessee. He also referred to Schedule II to the Act, the Companies Act, 1956 and Clause 7 of Part III of Schedule VI to the Companies Act, 1956 and stated that if these provisions are taken into consideration, the debenture stock redemption fund was only a reserve, and therefore, the ITO was justified in not excluding the amount. He further referred to the Balance Sheet and urged that the general reserve is to be taken as it was on 1-4-1974, whereas the dividend pertained for the year 1973 and, therefore, the ITO was justified in not excluding the sum of Rs. 24,32,250.
5. Shri Chakraborty, the senior departmental representative, urged that the Commissioner took action under Section 16(1) on the ground that the assessment completed by the ITO under Section 6(2) of the Act was erroneous and prejudicial to the interest of the revenue. The assessee did not challenge Ground No. 1 on this issue. Therefore, the assessee accepts that the order passed by the ITO was erroneous and prejudicial to the interest of the revenue. He referred to the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra) and read the observation of the Supreme Court particularly on pages 567 to 569 and urged that the debenture stock redemption reserve created by the assessee was only a provision which was created by the assessee to meet out the ascertained liability of repaying the debenture when the same would mature for repayment. Shri Chakraborty stated that one should not go by the nomenclature. The assessee had simply used the word 'reserve', which would not determine the nature of the provision created by the assessee. The assessee, in effect, has made a provision for the fund, for the repayment of debenture, and, therefore, if the conclusion of the Supreme Court on this point is taken into consideration, the Commissioner was justified in directing the ITO to exclude the amount of Rs 24,00,000. He further stated that exclusion of dividend of Rs. 24,32,250 is covered by the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra). Therefore, the second direction of the Commissioner was also correct. He, therefore, urged that the order of the Commissioner should be maintained.
6. Shri Nagpal, the counsel of the assessee, replying to the argument of the assessee stated that he has not addressed on the first ground directly, but he had argued the cases on merits on both the issues to show that the order passed by the ITO was neither erroneous nor prejudicial to the interest of the revenue.
7. The assessee-company offered for subscription by the public, debenture stock secured by a trust deed between the company and the trustees, Dalhousie Holdings Ltd. The stock, of the value of Rs. 75 lakhs, carried interest at 7| per cent and was to be redeemed or paid off between the periods 1-4-1977 and 31-3-1979. The debenture stock was issued in the year 1967. According to clause 6(a) of the trust deed the debenture stock was secured against the hypothecation of specified shares held by Shaw Wallace in certain companies (specified in the Second Schedule to the trust deed) and further a charge was created in favour of the trustees of the undertaking and assets of Shaw Wallace (excluding the specified shareholdings hypothecated). Subject to all existing mortgages, pledges and hypothecations, the charge, in respect of the undertaking and its other property and assets, was to rank as a floating charge and was in no way to hinder or prevent Shaw Wallace from selling, mortgaging, charging, leasing, or otherwise disposing of, or dealing with, such assets (other than fixed assets), in the ordinary course of its business. The conditions to be endorsed on the stock certificate have been set out in Clause 45 of the trust deed. Inter alia, a condition is that during the financial year ending 31-12-1970 and during every succeeding financial year while the stock, or any part thereof, remaining outstanding, the company shall out of its divisible profits (as defined in the trust deed) have to set apart annually, a sum of Rs. 6 lakhs and credit such sum to a reserve to be called debenture stock redemption reserve provided that the company may, in any financial year, credit to the said reserve a sum in excess of the aforesaid annual contribution and the amount of such excess may be applied by the company in reduction pro tanto of its obligation under this condition for any subsequent year or years. The company may at any time, and from time to time, apply the whole or any part of the amount, for the time being standing to the credit of the said reserve, in the purchase of the stock in the market, at any price not exceeding par value, exclusive of accrued interest and costs of purchases, or with the written consent of the trustees at a price in excess of the par value. The company may also utilise such amount for redeeming the stock after 1-4-1977, as provided, but any accrued interest shall be payable by the company otherwise than out of the reserve.
8. The surtax is leviable under Section 4 of the Companies (Profits) Surtax Act, 1964. The surtax is levied in respect of 'chargeable profit' of a company which exceeds the statutory deduction. The 'chargeable profit' and 'statutory deduction' are defined under Section 2(5) and (8) of the Act. The 'chargeable profit' is adjusted in accordance with the provisions of the First Schedule whereas the 'statutory deduction' is computed with reference to the Second Schedule of the Act. The Second Schedule describes the capital of the company, which would include certain reserves. The asses-see-company has created the debenture stock redemption reserve at Rs. 24,00,000, which was included by the ITO for allowing statutory deduction to the assessee.
This had been found to be erroneous by the Commissioner. Shri Chakraborty, the senior departmental representative, urged that the assessee has not advanced any argument on his first ground that the order of the ITO was not erroneous and prejudicial to the interest of the revenue and, therefore, he accepted this fact. The assessee's counsel, on the other hand, in his reply has stated that he had argued the case on merit by which he has proved that the order of the ITO was not erroneous as well as prejudicial-to the interest of the revenue. It is true that the counsel of the assessee has not taken up Ground No. 1 directly but, however, by advancing arguments on other grounds, he had tried to prove indirectly that the order passed by the ITO was neither erroneous nor prejudicial to the interest of the revenue. The points in issue are two: Whether general reserve would have been diminished by Rs. 24,32,250 and Rs. 24,00,000 for dividend and debenture stock redemption reserve. So far as the proposed dividend of Rs. 24,32,250 is concerned, the inclusion of this amount in the capital base by the ITO is erroneous in view of the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra). Consequently, the action of the Commissioner on this issue is maintained.
9. The only other point is whether the Commissioner was justified in directing the ITO to exclude Rs. 24,00,000 from the capital base. The main controversy is whether the reserve created by the assessee for the debenture stock redemption reserve was a reserve or it was a provision.
Whether a particular sum is a reserve or a provision could only be determined by applying the principles of accountancy. William Pickles in Accountancy (Fourth Edition) at pages 0717-0718 describes reserves and provisions as follows : The lack of uniformity and looseness in the past in the employment of the term 'reserve' have tended not only to create confusion in the mind of the student but to difficulties in the proper understanding of the financial position of businesses as shown in their Balance Sheets. The matter has now been considerably clarified by the Companies Acts 1948 and 1967, and although the requirements of the Acts apply only to limited companies, it is proposed in this Chapter to deal with reserves and provisions on the lines of the definitions laid down in the Acts. The reader should, however, bear in mind that at this stage the matter is being considered more in broad principle than in regard to the specific requirements of the Acts which apply to the published accounts of limited companies.
As a preliminary to closer study, reserves and provisions may be defined as follows : 1. Reserves are amounts set aside out of profits and other surpluses which are not designed to meet any liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance sheet.
2. Provisions are amounts set aside out of profits and other surpluses to provide for : (b) any known liability of which the amount cannot be determined with substantial accuracy.
1. Any amount set aside for the purposes described in (2)(a) and (b) above in excess of estimated requirements must be regarded as a reserve.
2. Sums set aside to meet known liabilities of which the amount can be determined with substantial accuracy do not fall within the definition of a provision and should therefore be described as accruals or accrued liabilities. Reserves are in effect part of the undistributed profits of the business and therefore part of the proprietorship, whereas provisions and accruals are a diminution of proprietorship in the form of a liability or diminution of an asset.
The former are broadly appropriations of, the latter charges against profits.
The reserves and provisions had been considered by Spicer and Peigler in Book-keeping and Accounts, 15th Edition, page 42 in the following terms : The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss 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 and reserve funds are shown as part of the proprietor's interest.
Further, the reserve and provision have also been dealt with in clause 7 of Part III of Schedule VI of the Companies Act, 1956 which are as follows : 7. (1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires,- (a) the expression 'provision' shall, subject to Sub-clause (2) of this clause, means any amount written off or retained byway 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 ; (b) 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 ; (c) 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; and in this sub-clause the expression 'liability' shall include all liabilities in respect of expenditure contracted for and all disputed or contingent liabilities.
The nature of reserve had further been described in the form of Balance Sheet in Part I of Schedule VI under the head "Reserve and Surplus".
The same is appearing as follows : (4) Other Reserves specifying the nature of each reserve and the amount in respect thereof.
(5) Surplus, i.e., balance in Profit and Loss Account after providing for proposed allocations namely :- Further, the reserve and provision had also been a subject of discussion by the Hon'ble Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra) on which reliance has been placed by the assessee as well as by the departmental representative. The Hon'ble Supreme Court had defined the reserve and provision as follows : The expression 'reserve' has not been defined in the Super Profits Tax Act, 1963, or the C. (P.) S.T. Act, 1964. The dictionaries do not make any distinction between the two concepts 'reserve' and 'provision' while giving their primary meanings, whereas in the context of those Acts a clear distinction between the two is implied. Though the expression 'reserve' is not defined, since it occurs in taxing statutes applicable to companies only and to no other assessable entities, the expression has to be understood in its popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to the words 'reserves' and 'provisions' in the Companies Act, 1956, dealing with the preparation of the balance sheet and the 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.Metal Box Co. of India Ltd. v. Their Workmen  73 ITR 53 followed.
Though the term 'provision' is defined in clause 7 of Part III of Schedule VI to the Companies Act, 1956, positively by specifying what it means, the definition of 'reserve' is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term 'reserve'. The effect of reading the two definitions together is that if any retention or appropriation of a sura falls within the definition of '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 the 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, because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term 'reserve' may have to be availed of. If any retention or appropriation of a sum is not a provision, i.e., it is not designed to meet depreciation, renewals or diminution in the value of assets or any known liability, the same is not necessarily a reserve. The question whether the concerned amounts constitute 'reserves' or not will have to be decided by having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriation had been made.
The true nature and character of the appropriation must be determined with reference to the substance of the matter : this means that one must have regard to the intention with which and the purpose for which the appropriation has been made, such intention and purpose being gathered from the surrounding circumstances. The following aspects provide some guidelines : (a) a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general reserve or a specific reserve, (A) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised in future for a specific purpose and on a specific occasion, and (c) a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend in the same year would run counter to any intention of making that amount a reserve, (pp. 560-61) 10. It is also clear from the judicial pronouncements that the accountancy principle should be followed for deciding the nature of an item. This view even had been adopted by the Supreme Court i n Vazir Sultan Tobacco Co. Ltd. (supra). Further, assistance can be taken from CIT v. J.K. Cotton Spg. & Wvg. Mills Ltd.  98 ITR 153 (All.), Challapalli Sugars Ltd. v. CIT  98 ITR 167 (SC), CIT v. Rajendra Prasad Moody  115 ITR 519 (SC), Sutlej Cotton Mills Ltd. v. CIT  116 ITR 1 (SC), CIT v. Tata Mills Ltd.  118 ITR 496 (Bom.) and CIT v. Saurashtra Cement & Chemical Industries Ltd.  127 ITR 47 (Guj.). If the principles of reserve as laid down in the Accountancy Books, as stated above, as well as the guidelines prescribed by the Hon'ble Supreme Court in Vazir Sultan Tobacco Co. Ltd. (supra) are taken into consideration, the debenture stock redemption reserve created by the assessee was only a reserve. This conclusion is based upon the following facts : (i) Creation of debenture stock redemption reserve had been recommended by the Directors in their report (page 1 of the assessee's paper book).
(ii) The 'reserve' has been created out of the surplus profit of the assessee (page 2 of the paper book).
(iii) The 'reserve' has been created in the Profit and Loss Appropriation Account (page 3 of the paper book).
(iv) The 'reserve' has not been created in Profit and Loss Account (page 3 of the paper book).
(v) The 'reserve' so created by the assessee has not diminished the assets of the assessee.
(vi) The 'reserve' created by the assessee is appearing as 'reserve' under the head 'Reserve and Surplus' in the Balance Sheet of the assessee.
(vii) The 'reserve' as appearing in the Balance Sheet is in accordance with the requirements of Part I of Schedule VI of the Companies Act, 1956.
(viii) The 'reserve' has been created by carving out a part of the surplus fund of the assessee.
(ix) The debenture stock account would be reduced, as and when the payment is made, and ultimately the balance in debenture account on total payment would be nil. Even if the debenture account becomes nil, the debenture stock redemption reserve would appear in the Balance Sheet which would ultimately form a part of the general reserve.
(x) It has not created any charge on the profit and the reserve created by the assessee was not an allowable deduction.
11. The above conclusion is further supported by the decision in Addl.
CIT v. Bharat Fritz Werner (P.) Ltd.  118 ITR 25 (Kar.). The facts are similar to the facts in the present case. The assessee issued redeemable cumulative preference shares for Rs. 6 lakhs which were redeemable on 31-12-1970, or earlier, at the option of the assessee.
The assessee created preference share capital redemption reserve. The assessee claimed before the ITO that the reserve should be considered while determining the capital base. The ITO rejected the claim of the assessee but, however, the AAC accepted the same and the finding of the AAC was confirmed by the Tribunal. The Commissioner, Mysore, was in reference and the Hon'ble High Court accepted the claim of the assessee. The assessee in the present case had only created the reserve against the debenture stock, whereas in the above case the reserve was created against the preference share capital and, therefore, even the above case supports the plea of the assessee.
12. The departmental representative in the course of the argument urged that the reserve as created by the assessee should not be decided only by nomenclature. The definition of 'reserve' along with the guidelines given by the Hon'ble Supreme Court, has been considered. The conclusion given above is, therefore, not based upon the nomenclature but it is based upon the true nature of the reserve created by the assessee.
Therefore, the ITO was justified in not excluding the sum of Rs. 24,00,000. As the order of the ITO is maintained on this issue, the order of the Commissioner is partly modified.
13. The second Appeal No. 34 (Cal.) of 1981 is arising out of the order of the ITO who had re-made the assessment when it was set aside by the Commissioner under Section 16(1) of the Act. The order of the Commissioner has been maintained so far as the exclusion of dividend of Rs. 24,32,250 is concerned. Consequently, the order of the Commissioner on this issue is maintained. The order of the Commissioner in giving direction to the ITO to exclude Rs. 24,00,000 has been reversed in the earlier paragraph. Consequently, the order of the Commissioner on this issue is modified and the original order of the ITO on this issue is maintained.