N.N. Goswamy, J.
1. This judgment will dispose of Income-tax Reference Nos. 4 to 7 of 1973 as they arise out of a common order of the Tribunal and the question of law referred is also the same.
2. At the instance of the additional Commissioner of Income-tax, Delhi, the Income-tax Appellate Tribunal has referred the following question of law for the opinion of this court :
'Whether, on the facts and in the circumstances of the case, the balance to the credit of the earned surplus accounts on the books of the assessed as on 1st day of the relevant previous year or any part thereof represented reserves with in the meaning of rule 1 to the second Schedule to the Companies (Profits) Surtax Act, 1964, as read with the Explanationn to the same rule ?'
3. The facts of this case lie in a very narrow compass and are not disputed. The assessed is a company incorporated in the united states of America having its head office in that country and one of its branches is in India. The assessed is treated as company under s. 217(2) of the Companies Act, 1956. The company files its returns for the assessment years 1966-67, 1967-68, 1968-69, 1969-70. In the returns the net chargeable profits were computed on the basis that the balance in 'earned surplus' was to be treated as a reserve and thus would form part of the capital of the company. The ITO took the view that the 'earned surplus' was not to be included in the 'reserve' and as such was not to be deemed a part of the capital on the basis of which the statutory deduction was to be computed under the provisions of the companies (profits) Surtax Act, 1964. The assessed filed an appeal before the AAC. The AAC, following the decision of the Tribunal in the case of this very assessed for the assessment year 1965-66, in Surtax Appeal No. 5 of 1967-68, dismissed the appeal.
4. The assessed filed a further appeal before the income-tax appellate Tribunal. The Tribunal on a consideration of the facts in the case came to the conclusion that the case was fully covered by the judgment of the Supreme Court in the case of First National City Bank v. CIT : 42ITR17(SC) and CIT v. Standard Vacuum Oil Co. : 59ITR685(SC) . The Tribunal further found that the Explanationn to r. 1 of the second Schedule to the Companies (Profits) Surtax Act, 1964, did not make any change in the essential legal position and as such the earned surplus was to be treated as a part of the reserve. Accordingly, the appeal was allowed.
5. At the instance of the Additional Commissioner, the Tribunal has submitted the statement of case and referred the above said question of law for the opinion of this court. In the case of CIT v. Standard Vacuum Oil Co.  59 ITR (SC), the facts were that the assessed, a non-resident company, incorporated in the USA with the object of taking over the assets of two other companies in consideration of the transfer of the assets, allotted to each company a certain number of shares. The said assessed company entered in its books of account the value of the assets taken over from the two companies and the excess of the net value of the assets transferred over the par value of the stock issued and the Seriall bonds was entered in account styled 'Capital paid in surplus'. Later, the Seriall bond issued to one of the two issued companies were redeemed and after some adjustments the 'Capital paid in surplus' account was reduced. However, thereafter, the said account stood unchanged at that figure. The net profits earned by the company year after year, subject to certain appropriations, were shown in the balance-sheet under the caption 'earned surplus'. The balance of 'earned surplus' was $29,557,597 at the end of 1945. It progressively increased thereafter and by the earned of 1948, stood at $73,766,592. On these facts, one of the question of consideration, with which we are concerned in the present case, was whether the 'capital paid in surplus' and the 'earned surplus' were reserve within the meaning of r. 2(1) of the Schedule. Their Lordships of the Supreme Court, after discussing the earlier case of First National City Bank : 42ITR17(SC) , held : 59ITR699(SC)
'We are in this dealing with a foreign company and the system of accounting followed by the company is different in important respects from the system which obtains in India. Companies in India maintain diverse types of reserves, such as capital reserve, reserve for redemption of debentures, reserve for replacement of plant and machinery, reserve for buying new plant to be added to the existing ones, reserve for bad and doubtful debts, reserve for payment of dividend and general reserve. Depreciation reserve within the limit prescribed by the income-tax Act or the Rules there under is the only reserve which is a permissible allowance in the computation of taxable profits. In its ordinary meaning the expression 'reserve' means something specifically kept apart for the future use or for a specific occasion. The accumulated profit of the assessed-company, according to the system of accounting at the end of the year, were not carried forward into the account of the next year as they could not be, according to the system of accounting prevalent in the United States. They had to be allocated to some account and they were allocated to 'earned surplus', which was intended for and was used in subsequent years for the purpose of the business of the assessed-company. The account in which this amount was carried retained its identity year after year....The table disclosed that the balance of 'earned surplus' at the end of the year did not merge into the account of the subsequent year. It represented a specific account into which were added the net profits of the year and appropriations were made out of it and the balance was regarded as 'earned surplus' at the end of the year. This account was specifically allocated for utilisation for the purpose of business year after year. It was an account in which the net profit less the appropriations were added and the account was intended for application in extending the business of the assessed-company. The amount entered in the account 'earned surplus' cannot thereforee be regarded as mere unallocated profits at the end of the accounting year.'
6. The learned counsel for the department rightly conceded that, but for the Explanationn to r. 1 of the second schedule to the Surtax Act, 1964, the present case was fully covered by the aforesaid observations of their Lordships of the Supreme Court. It was submitted that the provision similar to the Explanationn to r. 1 of the Second Schedule of the Companies (profits) Surtax Act was absent in the Super Profits Tax Act, 1963, and as such the judgment of the supreme Court are distinguishable on facts. The Explanationn is to the following effect :
'For the removal of doubt it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of items (5) or item (6) or item (7) under the heading 'Reserves and Surplus... in the 'Form of Balance-sheet' given in part I of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of the company under the provisions of the Schedule.'
7. The said items 5, 6, and 7 under the heading 'Reserves and Surplus' in the 'Form of Balance-Sheet' are as follows :-
'5. Surplus i.e., balance in profit and loss account after providing for proposed allocations, namely :-
Dividend, Bonus or Reserves. 6. Proposed additions to reserves.
7. Sinking Funds.'
8. Item 7 relating to Sinking Funds has not been relied upon by the counsel for the department and as such we need not discuss the same. In order to decide whether items 5 and 6 in any way change the legal position, we have to revert back to the two decisions of the Supreme Court cited above, In the case of First National City Bank : 42ITR17(SC) , the Supreme Court observed (pp. 22 and 23) :
'There is a different between the system of accounting of banking Companies in India and the united States..... In India at the end of an year of account of the unallocated profit or loss is carried forward to the account of the next year, and such unallocated amount gets merged in the account of that year. In the system of accounting in the U.S.A. each year's account is self-contained and nothing is carried forward. If after allocating the profits to diverse heads mentioned above any balance remains, it is credited to the 'undivided profits' which become part of the capital fund. If in any year as a result of the allocation there is a loss the accumulated 'undivided profits' of the previous years are drawn upon and if that fund is exhausted the banking company drawn upon the surplus. In its very nature the 'undivided profits' are accumulation of amounts of residue on hand at the end of the year of successive periods of accounting and these amounts are by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company.'
9. The aforesaid observations were duly approved in the case of Standard Vacuum Oil Company : 59ITR685(SC) and it was observed(p. 695) :
'It is true that the court in that case was dealing with a case of a banking company. But he characteristics noted are not peculiar to the accounts of a banking company : they are applicable with appropriate variations to the accounts of all companies, in which different nomenclatures are used in the accounts to designate the residue on hand as 'surplus', 'undivided profits' or 'earned surplus'.'
10. Applying the aforesaid observation to the facts of the present case, the tribunal recorded the following findings :
'The addition is an effective allocation which did not require any formality or ceremony for being treated as a part of the general earned surplus account. The addition, thereforee, was not a mere proposed addition but an addition was a fait accompli.'
11. We are of the opinion that the Tribunal was right in observing that the whole idea of the Explanationn seems to be to exclude from the capital reserves, allocation which had not been finalised or which had not received the seal of approval from the general body of the company. However, in the present case, the allocation had already been brought about and it could not be said that the intention of the Legislature was to exclude the same from the reserves. We are, thereforee, of the opinion that the conclusion of the tribunal that the Explanationn to r. 1 did not in any way change the legal position, are correct. Accordingly, we answer the question referred in the affirmative, i.e., against the department and in favor of the assessed. The assessed will be entitled to its costs. Counsel's fee Rs. 500.