1. The first ground of appeal in this case is with regard to the exclusion of the sum of Rs. 86,24,000 from the capital account of the assessee-company in terms of the Second Schedule of the Companies (Profits) Surtax Act, 1964 ('the Act') on the ground that the said amount represented dividend declared out of the general reserve. The point in issue stands now concluded against the assessee vide the ratio of the decision of the Hon'ble Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT  132 ITR 559. The issue is, therefore, decided against the assessee and the order of the learned Commissioner (Appeals) upholding the exclusion of the said sum is upheld.2. The next controversy is with regard to the exclusion of a further sum of Rs. 78,69,681 representing the amount transferred to 'general reserve' from 'revaluation reserve' while computing the assessee's capital base in terms of Explanation 1 to Rule 2 of the Second Schedule of the Act. The revaluation reserve had been created by the assessee-company in 1966 when the devaluation of rupee had taken place by valuing the assets in question at a higher sum than the book value of the said assets at that time and creating the corresponding credit by crediting the revaluation reserve account. Up to the assessment year 1974-75, the said revaluation reserve was not being included in the capital of the assessee-company in terms of the above referred Explanation 1 to Rule 2 of the Second Schedule which reads as follows : A paid-up share capital or reserve brought into existence by creating or increasing (by revaluation or otherwise) any book asset is not capital for computing the capital of a company for the purposes of this Act.
3. At the end of the accounting period corresponding to the assessment year 1974-75, i.e., on 30-9-1973, the amount in question standing to the credit of revaluation reserve account was transferred to general reserve account by debiting the revaluation reserve account and crediting general reserve account, so that, as on 1-10-1973, revaluation reserve account did not appear in the balance sheet of the company at all. While transferring the revaluation reserve account to the genera! reserve account, the board of directors of the company made the following report to the shareholders in their annual report for the year ended 30-9-1973 : Consequent upon the devaluation of rupee in June 1966, the values of imported fixed assets of the company were written up on 30-9-1966 to the extent of 57.5 per cent of their c.i.f. costs as depreciated up to that date. This resulted in an increase in the value of such imported assets in the company's books by Rs. 11,01,697 and a corresponding amount was credited to the revaluation reserve. Many of these assets have since been fully depreciated and it has been decided to transfer from revaluation reserve to general reserve a sum of Rs. 78,69,681 equivalent to the amount by which the value of such assets, now fully depreciated, were written up at the time of devaluation.
4. The aforesaid amount was nevertheless excluded by the ITO while computing the capital of the assessee-company, as in his opinion, despite such transfer, the nature of the said reserve had not changed and the said reserve had not ceased to exist. On appeal, the Commissioner (Appeals) confirmed this action of the ITO. Hence, the present appeal on the point before us.
5. The learned counsel for the assessee assailed the order of the Commissioner (Appeals) on several, counts. Firstly, it was stated by him that for computing capital of the company for the purpose of the Act, one has to look at the balance sheet of the company as on the first day of the previous year relevant to the assessment year concerned and as on that day the revaluation reserve account did not stand in the balance sheet of the assessee-company, there was no occasion for the ITO to have excluded the sum which earlier formed part of the revaluation reserve account, but which stood since squared up in the accounts on the last day of the previous accounting year. When the said balance did not exist as on the first day of the previous year, the ITO had no occasion to deem it as still existing and excluding the same while computing the capital. Secondly, it was pointed out that the revaluation 'reserve account could not have been excluded even in earlier years while computing the capital of the company, for, in terms of Explanation 1 to Rule 2 of the Second Schedule what had to be excluded was the reserve "brought into existence by creating of increasing (by revaluation or otherwise) any book asset". The machines, etc., of the assessee-company could not be described as 'book asset', they were real assets and their revaluation was not caught in the mischief of the Explanation. It was only the revaluation of the book asset of intangible nature, for example, goodwill which would be affected by the said Explanation 1. Support for the above view was drawn from the following observations of their Lordships of the Supreme Court in the case of CIT v. Standard Vacuum Oil Co.  59 ITR 685 : The Explanation to Rule 2 has no relevance in the present case. The difference between the assets received by the company and the par value of the shares issued cannot be called a book asset 'brought into existence by creating or increasing (by revaluation or otherwise)'. The assets received by the assessee-company are real and tangible assets.... (p. 694) According to the learned counsel, the above observations clearly underscored the difference between a book asset and the real and tangible assets and inasmuch as in the present case, the revaluation reserve was created by revaluing the tangible and real assets there could be no question of revaluation reserve being hit by the mischief of Explanation 1 to Rule 2 of the Act.
6. Thirdly, the learned counsel for the assessee drew our attention to the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India on the following query, which was referred to the Expert Advisory Committee for its opinion : As you are aware, increases in values arising out of any revaluation of any items of fixed assets are required to be shown as revaluation reserve in the accounts which is in the nature of capital reserve, that is, not being free for distribution as dividend through profit and loss account. However, when any or some of these assets are sold or discarded then the relevant increases arising out of the revaluation may be transferred to revenue reserves. There appears to be some difference of opinion as to whether similar transfers may be made to revenue reserves after any or some of these revalued items of fixed assets are fully written off (i.e., fully depreciated) in the accounts. We shall, therefore, be grateful if you will refer this question to the Expert Advisory Committee for its consideration and let us know in due course, the Committee's views in this connection.
If any items of the Fixed Assets are revalued and the increase in value is shown on the revaluation reserve, appropriate amounts may be transferred from such reserve to revenue reserve when some or all of the revalued items of fixed assets are fully written off (i.e., fully depreciated) in the accounts or sold or otherwise disposed of or retired.
The learned counsel for the assessee explained that the directors had transferred revaluation reserve account to the general reserve account on the basis of the above opinion and their action in the circumstances was entirely justified.
7. On behalf of the revenue, the above submissions were stoutly opposed and it was urged that by merely transferring the revaluation reserve to the general reserve, the nature of the sum which earlier represented revaluation reserve could not be changed into that of general reserve and if revaluation reserve was to be excluded from the computation of the capital in earlier years on account of the operation of Explanation 1 to Rule 2 of the Second Schedule, there was no logic in the submission of the assessee that the same treatment should not be given this year to the amount representing revaluation reserve simply because the sum stands transferred this year to the general reserve account.
The opinion of the Expert Advisory Committee, submitted the learned departmental representative, might be good authority for transferring the revaluation reserve account to the general reserve account, but that did not constitute good authority for determining as to whether or not the reserve in question would be excluded from the computation of the capital for the purpose of the Second Schedule. For that, guidance would have to be taken from the plain language of Explanation 1 to Rule 2 of the Second Schedule. The distinction between the 'book asset' and 'real asset' which was sought to be drawn by the learned counsel for the assessee was also, according to the learned departmental representative, unreal on the facts and in the circumstances of the present case. The facts of the case relied upon by the assessee, namely, Standard Vacuum Oil Co. (supra) were altogether different and the observations made by their Lordships of the Supreme Court in a different context could not be imported into the present context for interpreting the provisions of the Act.
8. We have carefully examined the facts of the case and the rival submissions. Under Rule 1 of the Second Schedule of the Act, the capital of a company is to be computed by aggregating the following amounts as on the first day of the previous year relevant to the assessment year : (ii) its reserves styled as development rebate reserve created under Section 34 of the Income-tax Act, or investment allowance reserve created under Section 32A of the Income-tax Act.
(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 purpose of the Income-tax Act.
The paid-up share capital could be one either paid in cash in its entirety or was paid for otherwise than in cash and could include the paid-up share capital brought into existence by creating or increasing (by revaluation or otherwise) any book asset. A reserve could similarly be created either out of the profits of the company or out of the capital appreciation of the company. The creation of paid-up share capital or reserve on account of creation or revaluation of assets is the subject-matter of Explanation 1 to Rule 2. If the aforesaid Explanation were not there, the amount which was part of paid-up share capital or part of reserve, howsoever brought into existence, would be part of the capital of the company in terms of Rule 1. Rule 2 is an exception to Rule 1 and the effect of Rule 2 is that part of the capital computed under Rule 1 is excluded on account of the existence of certain conditions mentioned in Rule 2. Explanation 1 to the aforesaid rule expands the scope and ambit of the rule by taking within its sweep even the paid-up share capital or reserve which has been brought into existence by creating a book asset or by increasing the value of a book asset (by revaluation or otherwise). A 'book asset' would normally mean an asset entered in the books of account of the company. It also sometimes has the meaning of an intangible asset like goodwill or preliminary expenses or amount of losses, which appear on the assets side of the balance sheet. Some of the items like preliminary expenses or losses are not assets at all and, therefore, there could be no question of their revaluation and consequent surplus arising therefrom. But goodwill is certainly an asset which can either be 'created' if not already there to begin with, or the value of which can be increased in course of time on account of the standing of the company. The 'creation' of a book asset, apparently, excludes the acquisition' of a book asset. The 'creation is done by an act of the company. Before its 'creation', the asset was not in existence ; after the company decided to create it and passed the consequent entry in its books, it appears in the balance sheet. The corresponding credit, on account of the appearance of the new asset in the balance sheet, could be given either to the paid-up capital account or to a reserve account.
In either situation, the paid-up capital or reserve so created is to be excluded from the computation of capital in terms of Explanation 1 to Rule 2. In the present case, it is common ground that new asset has not been 'created' by the company in the aforementioned sense and, as such, there is nothing to be excluded from the computation of the capital of the assessee-company on the ground that part of the paid-up capital or reserve has been brought into existence on account of the creation of a book asset. In the sense as understood above, it appears to us that a book asset when 'created' would normally mean an intangible asset. A real asset cannot be created by merely passing an entry in the books.
9. The same need not, however, be true when it is a case of increasing the value of a book asset. The asset is already in existence in this case and so, there is no question of creating it by the act of a company, as in the earlier situation. The company is only increasing its value and thereby a surplus is being created which gets reflected on the liability side in the form of either increased paid-up capital or creation of an additional reserve. An intangible asset like goodwill can also be revalued at a higher price and so also the tangible assets.
There is nothing in the context to suggest that in this situation too the book asset would mean only an intangible asset and that Legislature intended to exclude the real assets like machines, etc., from the scope of the description of 'book asset'.
10. It may, of course, be said and it was indeed the suggestion of the revenue that creation of a book asset may also involve creation of a tangible asset out of the internal resources of the company, for example, by fabrication of a machine in its own workshop by the company. If the words 'creation of an asset' had appeared alone in the context in which it appears in the Explanation, the above interpretation might have been correct, but in the setting in which the said words appear, it had to take its colour from the words immediately following it, namely, increasing (by revaluation or otherwise) 'any book asset'. The above words appear immediately after the word 'creating' and in between appears the conjunction 'or'. The principle of ejusdem generis would, in our opinion, apply to the interpretation of the word 'creating' and, thus, understood, it is to be held that the Explanation does not visualise the act of acquisition of an asset by spending the resources of the company. When resources are acquired first and "the asset is acquired out of them, there would be no question of the paid-up capital or reserve being created because of the creation of the assets, rather acquisition of the asset is the result of the resources having been acquired first. In one situation, the creation of paid-up capital and reserve is the effect and the creation or increasing the value of an asset is the cause, in the other, the acquisition of additional resources or capital is the cause and the acquisition of asset is its effect. The Explanation covers the situation where an asset, which is in existence, is increased in value or, if an asset is not in existence, it is brought into existence by an act of the company without spending its resources. As already explained, a book asset created in the aforesaid manner could be only an intangible asset like goodwill, which is self-generated and for acquiring which, resources of the company are not utilized. When an existing book asset is increased in value, there is also no spending or utilisation of the resources of the company. Something already exists in the balance sheet of the company and its value is increased arithmetically in the books and thereby a surplus is created on account of the difference in the market price of the assets and the book value of the assets. This surplus, though notional, may be real but the statute requires that even if it be real, it would be excluded from the computation of the capital of the company, for no fresh resources or capital are spent by the company in order to acquire the said assets.
The said assets existed with the company and have appreciated in value and the company is, therefore, entitled to reflect the real state of affairs in its balance sheet by appreciating their value on the assets side and by creating a corresponding paid-up capital or reserve on the credit side. But such act of increasing capital or creating a reserve howsoever correct from the accounting point of view, would be ignored while computing capital for the purpose of the Act.
11. The observations of the Hon'ble Supreme Court in the case of Standard Vacuum Oil Co. (supra), have to be understood in the context of the peculiar facts of that case and the said facts bear no resemblance to the facts of the present case. There, it was the case of amalgamation of two companies, bringing into existence a third amalgamated company. The real value of the assets of the amalgamating companies was much more than the face value of the shares allotted to the said amalgamating companies in full satisfaction of their claims.
The question for determination was whether the difference between the face value of the shares allotted to the two amalgamating companies and the real value of the assets, which had been acquired by the amalgamated company from the amalgamating companies and which was shown in the accounts as 'capital paid in surplus' account, was in the nature of 'premium' at which the shares of the amalgamated company had been issued to the amalgamating companies. The amalgamated company did not have in existence any asset before its birth, which might have been 'revalued' by it. It was in the process of coming into existence by acquiring the assets of the amalgamating companies and allotting its fully paid shares to them. The real value of the assets acquired was more than the face value of the shares and the difference represented the 'premium' which the amalgamating companies had agreed to pay, so to say, for acquiring the fully paid-up shares of the amalgamated company.
It is in this context that their Lordships had observed that the Explanation to Rule 2 to Business Profits Tax Act, 1947 (which is in pan materia with the language of the Explanation presently under consideration) has 'no relevance to the present case'. The above observation is significant because their Lordships were faced with the case wherein neither there had been a 'creation' of new asset by the amalgamated company, nor did it 'revalue' any of its existing assets.
It was a case where the company was buying the assets from the market, so to say and allotting to the vendors of the said assets its own shares, fully paid and charging from them a premium for such allotment of shares. The following observations of their Lordships have to be understood in the above context : ...The difference between the assets received by the company and the par value of the shares issued cannot be called a book asset 'brought into existence by creating or increasing (by revaluation or otherwise)'. The assets received by the assessee-company are real and tangible assets. It is only for accountancy purposes that a part of the value of the assets is allocated to the par value of the shares and the balance to the 'Capital Surplus brought in' account....(p. 694) The aforesaid observations of their Lordships cannot be interpreted to mean that their Lordships were intending to make a distinction between the 'book' asset and the 'real' asset. They were, in fact, considering a situation, where a company had purchased real assets and this situation was incapable of being described as one in which 'book assets' are brought into existence by creating or increasing (by revaluation or otherwise). The aforesaid case, therefore, does not, in our opinion, advance the assessee's case any further.
12. There appears, however, to be merit in the assessee's third submission, namely, that the original revaluation reserve had, in fact, lost its original moorings on account of the machines, etc., which had originally been revalued, having been fully depreciated by the end of the accounting period ending on 30-9-1973. As the value of the machines was depreciated, the need for a matching credit entry on the liability side also disappeared. The original revaluation reserve account thus lost its raison d etre and could have been written off by the company over the years. If, however, even after the machines had been fully depreciated, the reserve still stood in the balance sheet, the only inference possible would be that the said revaluation reserve reflected nothing but the accumulation of surpluses of the company from sources other than the revaluation of the assets and so, there would be every justification to merge it with the general reserve rather than keeping it as a separate reserve with the above nomenclature for, after the depreciation of the assets, the aforementioned nomenclature lost its meaning and validity. Therefore, the transfer of the revaluation reserve account to general reserve account was an accounting propriety and so it was rightly done by the assessee-company and the above mode of transfer of the revaluation reserve to the general reserve is rightly advised by the Expert Advisory Committee of the Institute of Chartered Accountants, whose opinion has been relied upon by the assessee in support of its action. The nature of the revaluation reserve account, after the revalued items of fixed assets are fully written off, would no more be the same as was its original nature and, as such, Explanation 1 to Rule 2 would cease to apply to it as soon as its quality changed. The position would, however, be different if the revalued items of fixed assets had not been fully written off and yet the assessee had transferred the revaluation reserve account to the general reserve account. Despite the change in the nomenclature in that case, the authorities would be justified to treat the transferred part of the reserve as revaluation reserve, despite the change in its nomenclature, for such change in the name does not bring about a change in the nature and quality of the reserve. But, when the nature and the quality of the reserve changed, a change in the nomenclature is but appropriate and due regard should be given to it. In the present case, as the report of the directors to the shareholders indicates, the transfer of revaluation reserve account to general reserve account was done because 'many of these assets had since been fully depreciated'.
The amount transferred from revaluation reserve to general reserve was Rs. 78,69,681 "equivalent to the amount by which the value of such assets now fully depreciated were written off at the time of devaluation". This being the factual position, we feel that the transfer of the revaluation reserve to general reserve was justified on account of the change in the nature and the quality of the reserve. The reserve to the extent of Rs. 78,69,681 was no more a revaluation reserve. It rather represented accumulation of the company's profits and other surpluses other than those created by the revaluation of the assets and, therefore, the Explanation 1 to Rule 2 would not apply to the said sum of Rs. 78,69,681. The exclusion of the said sum, while computing the capital of the assessee-company under Rule 1 would not, in our opinion, be justified. We, accordingly, reverse the orders of the authorities below and allow the assessee's appeal.