1. The Income-tax Appellate Tribunal, Delhi Bench 'D', referred, under s. 256(1) of the I.T. Act, 1961, read with s. 18 of the Companies (Profits) Surtax Act, 1964, the following question for the decision of this court :
'Whether, on the facts and in the circumstances of the case, the amount of Rs. 12,02,325 (forming part of the sum of Rs. 25,46,717) credited to the 'provision for rent of UNICEF Plant and Machinery Account', is a reserve within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'
2. The facts of the case are brief. The Government of India entered into an agreement with UNICEF and WHO, Agencies of the United Nations Organisation, whereby the Government of India was to receive free of cost plant and machinery and free technical assistance for manufacture of DDT in India. Pursuant thereto, the Government of India incorporated a joint stock company under the name and style of Hindustan Insecticides Limited, the assessed herein. The plant and machinery received by the Government of India was allowed to be used by the assessed with a direction that the assessed will discharge the obligations of the Government of India under the agreement. The matter as to how the plant and machinery should be capitalised in the balance-sheet was raised by the assessed. By letter dated December 5, 1957, the assessed was informed of the Government decision in this regard. This was :
'(1) The cost of free technical assistance by the UNT 44 in terms of the Joint Plant of Operation need not be capitalised.
(2) The plant and equipment supplied by the UNICEF should not be exhibited in the balance-sheet of the company as long as these are not actually transferred to the company. However, as the plant and equipment will be used by the company, an amount equal to the estimated depreciation may be charged to the cost of production in the form of rent by contra-credit to a suitable reserve. If and when the ownership of the plant and equipment is transferred to the company, the assets may be taken over in the books of the company at their original value.'
3. The plant and machinery were received some time in 1955 or 1956. As on December 5, 1957, the question as to how the plant and equipment supplied by the UNICEF should be exhibited in the balance-sheet of the assessed was not clear because everything was to depend upon the Government decision regarding the mode of transfer. If the plant and equipment were transferred free to the assessed, the original value will have to be shown under capital reserve on the liabilities side of the balance-sheet. If, however, these were transferred at a cost equal to their original value, in lieu of share capital after compliance of ss. 75(1)(d) and 75(2) of the Companies Act, 1956. It was further stated in the aforesaid letter that when the plant and equipment were ultimately transferred to the company at their original value the amount of depreciation credited to the date of transfer in the depreciation reserve was to be shown as deduction on the assets side of the balance-sheet in order to comply with the requirements of Schedule II of the Companies Act, 1956.
4. According to the direction of the Government, the assessed was required to charge an amount equal to estimated depreciation to the cost of production in the form of rent and the assessed was to make contra-credit to a suitable reserve. The assessed did not charge estimated depreciation in the form of rent in its manufacturing account but it charged it to profit and loss account and made contra-credit to provision for lease money in the balance-sheet. In this way, the assessed charged Rs. 26,47,170 in various years beginning from the accounting year March 31, 1956, to March 31, 1966 In proceedings for assessment of income-tax for the assessment years 1956-57 to 1960-61 a sum of Rs. 13,44,392 was allowed as deduction. However, for assessment years 1961-62 to 1965-66, the balance sum of Rs. 12,02,325 was not allowed as deduction. In the balance-sheet of the assessed as on March 31, 1964, the amount that figured was Rs. 25,46,717. This pertained to the amounts which were debited with the recital that it represented rent or lease money for UNICEF plant and machinery and corresponding credit was to the 'Provision for Rent on UNICEF Plant and Machinery Account'. Since the amount of Rs. 13,44,392 had already been allowed as deduction in the income-tax assessment for assessment years 1956-57 to 1960-61, it could not be allowed as deduction in terms of clause (iii) of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as 'the Act'). It is only to the extent of balance of Rs. 12,02,325 that we are concerned in the present reference. To complete the narration, it may be mentioned that a similar provision of Rs. 1,33,989 in the year ending March 31, 1965, raising the figure of total provision to Rs. 26,80,705 was made on November 30, 1965, on which date the Government intimated to the assessed that the value of the plant and equipment was Rs. 28,47,170 and asked the assessed to re-structure the capital as under and issue shares to the Government for the said sum :
Rs.(a) Authorised capital 1,30,00,000(b) Subscribed capital 1,25,47,000
5. The assessed issued share in favor of the Government of the face value of Rs. 28,47,170 against the price of the plant and machinery supplied by the Government.
6. In proceedings under the Surtax Act for the assessment year 1965-66, it was submitted before the Surtax Officer by the assessed that while computing the capital of the assessed for the purpose of surtax, the provision for lease money amounting to Rs. 25,46,717 should also be added to arrive at the capital of the company under the Second Schedule to the Act. The Surtax Officer negatived the contention of the assessed holding that the amount was simply a provision and was in the nature of liabilities payable to the party and could not be termed as 'reserve' of the assessed. The appeal of the assessed before the AAC of Surtax also failed who held that reserve for lease money was covered by the term 'other liabilities' (item 7 of 'Current liabilities and provision' in the form of balance-sheet) and consequently this could not be regarded as reserve for the assessed before the Income-tax Appellate Tribunal also failed. The Tribunal, however, clarified that the amounts debited by the assessed to the profit and loss account for assessment years 1956-57 to 1960-61 and amounting to Rs. 13,44,392 had admittedly been allowed as deductions in the respective income-tax assessments and it was thereforee clear that even if the sum of Rs. 25,46,717 could be treated as a reserve, the sum of Rs. 13,44,392 should be excluded there from in the computation of capital for the purpose of surtax. The Tribunal thus observed that even if the assessed were right in its contention, it could have succeeded only to the extent of Rs. 12,02,325. This is how the question set out in the beginning of this judgment has been referred for our decision.
7. The Act, by s. 4, imposes a levy of surtax on the amount of the chargeable profits of a company of the previous year as exceed the statutory deduction. The statutory deduction is ten per cent, of the capital of the company or Rs. 2 lakhs, whichever is greater. The chargeable profits have to be computed in accordance with the provisions of the First Schedule and the capital in accordance with those of the Second Schedule. We are here concerned with the Second Schedule, the relevant provisions of which may be first set out.
8. Rule 1 of Schedule II to the Companies (Profits) Surtax Act, 1964, lays down that :
'1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of -
(i) its paid-up share capital;
(ii) its reserves, if any, created under the proviso (b) of clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922 (11 of 1922), or under sub-section (3) of section 34 of the Income-tax Act, 1961, (43 of 1961);
(iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purpose of the Indian Income-tax Act, 1922 (11 of 1922) or the Income-tax Act, 1961 (43 of 1961).........
Explanationn : For the removal of doubts it is hereby declared that any amounts 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 'From 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 purpose of computation of the capital of a company under the provisions of this Schedule.'
9. The relevant provisions of the above Schedule to the Companies Act, 1956, may also be set out herein. The 'liabilities' column of the balance-sheet first provides for the share capital of the company and the details thereof. Next follows the heading 'Reserves and surplus' under which are listed seven items :
'1. Capital Reserves.
2. Capital Redemption Reserve.
3. Share Premium Account.
4. Other Reserves specifying the nature of each Reserve and the amount in respect thereof.
Less : Debit balance in profit and loss account (if any).
5. Surplus, i.e., balance in profit and loss account after providing for proposed allocations, viz., dividend, bonus or reserves.
6. Proposed additions to reserves.
7. Sinking funds.'
10. This is followed by details of 'Secured Loans' and unsecured loans and then comes the heading :
'Current liabilities and provisions'. Under this head appear the following items :
'A. Current liabilities :
2. Sundry creditors.
3. Subsidiary companies.
4. Advance payments and unexpired discounts for the portion for which values has still to be given, e.g., in the case of the following classes of companies : Newspaper, fire insurance, theatres, clubs, banking, steamship companies, etc.
5. Unclaimed dividends.
6. Other liabilities (if any).
7. Interest accrued but not due on loans.
B. Provisions :
8. Provisions for taxation.
9. Proposed dividends.
10. For contingencies.
11. For Provident fund scheme.
12. For insurance, pension and similar staff benefit schemes.
13. Other provisions.'
11. Then it is mentioned that a foot-note to the balance-sheet should be added to show separately -
'1. Claims against the company not acknowledged as debts.
2. Uncalled liability on shares partly paid.
3. Arrears of fixed cumulative dividends.
4. Estimated amount of contracts remaining to be executed on capital account not provided for.
5. Other moneys for which the company is contingently liable.'
12. It is also necessary to refer to clause 7 in Part III of the above Schedule which incorporates the definition of the expressions 'Provision ' and 'reserve'.
'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, 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;
(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, .......
and in this sub-clause the expression 'liability' shall include all liabilities in respect of expenditure contracted for and all disputed or contingent liabilities.
(2) Where -
(a) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or
(b) any amount retained by way of providing for any know liability;
is in excess of the amount which in the opinion of the directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this Schedule as a reserve and not as a provision.'
13. The question in the present reference involves the interpretation of the word 'reserve' used in the Second Schedule to the Act. The Supreme Court has held that the distinction between the two concepts of 'reserve' and 'provision' is fairly well known in commercial accountancy. In Vazir Sultan Tobacco Co. Ltd v. CIT : 132ITR559(SC) , the Supreme Court held as under (p. 569) :
'In other words, 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 P & L 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.'
14. The Supreme Court, after laying the aforesaid broad distinction, examined the two concepts as defined and dealt with by the Companies Act, 1956. It held as under (p. 570) :
'On a plain reading of clause 7(1)(a) and (b) and clause 7(2) above, it will appear clear that though the term 'provision' is defined 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'. In other words, the effect of reading the two definitions together is that if any 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. But it is clear beyond doubt that if any retention or appropriation of a sum is not a provision, that is to say, if it is not designated to meet depreciation, renewals or diminution in value of assets or any known liability, the same is not necessarily a reserve..... Having regard to the type of definitions of the two concepts which are to be found in clause 7 of Part III, the proper approach in our view would be first to ascertain whether the particular retention or appropriation of a sum falls within the expression 'provision' and if it does, then clearly the concerned sum will have to be excluded from the computation of capital, but in case the retention or appropriation of the sum is not a provision as defined, the question will have to be decided by reference to the true nature and character of the sum so retained or appropriated having regard to several factors as mentioned above and if the concerned sum is in fact a reserve then it will be taken into account for the computation of capital.'
15. After setting out the proper approach to be adopted in such a case, as indicated by the Supreme Court, it will be proper now to examine the appropriation in the present case.
16. It will be seen that till November, 1965, the Government of India did not make up its mind in regard to the mode or the terms of transfer to the assessed, and indeed it could not, as the Government itself did not know the terms under which the plant and machinery handed over to the Government would be formalised as that was a matter for bilateral discussions between the Government and the U.N. Organisation. At the same time, the assessed had to finalise its accounts for various years. The Government in its letter of December 5, 1957, did not say that any rent was payable to it as the question of the mode and terms of transfer was pending decision in consultation with various Ministries and the Comptroller and Auditor-General of India and the decision itself was dependent on the terms on which the Government itself was to get the plant and machinery from the UNO. The assessed was asked only to debit depreciation in a sum equal to the estimated depreciation and charge it to 'the cost of production in the form of rent by contra-credit to a suitable reserve'. Purporting to comply with the above instruction, the assessed debited the lease rent account and the credit was given to the account captioned 'lease money payable account' instead of a 'reserve account' in 1956-57 and 1957-58 assessment years and thereafter till the assessment under consideration to 'provision for lease money on UNICEF plant and machinery account.' It is not clear why the assessed showed these items in the first two years under 'payable account' and in the subsequent years under a 'provision account' contrary to the instructions of the Government. It may be mentioned that this amount was treated by the Tribunal as reserve for assessment year 1963-64 and for the year in question it was not so treated on account of insertion of the Explanationn in rule 1 of the Second Schedule to the Act.
17. In Vazir Sultan's case : 132ITR559(SC) , the Supreme Court was, prima facie, of the view that the Explanationn to the Act, being clarificatory in nature, was declaratory of the existing legal position.
18. Quite a few authorities were cited before us but it may not be necessary to refer to all of them. The Supreme Court in Vazir Sultan's case : 132ITR559(SC) , while laying down certain guidelines, held that the true nature and character of the appropriation must be determined with reference to the substance of the matter. In Addl. CIT v. Minerals & Metals Trading Corporation : 134ITR78(Delhi) , this court with reference to the definition of the expression 'provision' in rule 7 of Part III of Schedule VI to the Companies Act, 1956, held that it was very wide, but some meaning had to be given and significance to be attached to the use of the word 'known' in the definition. It was held that this did not merely mean that the assessed should have a knowledge that some liability, present, future, disputed or contingent may or may not arise at some date in future. It was held that it was necessary in that context to restrict the operation of this definition only to cases where there is no liability, i.e., the liability referable to and outstanding transaction or an even that has taken place as a result of which it is probable that liability will be fastened on the company. It should be a known liability though it cannot be accurately determined. In another decision of this court in Addl. CIT v. Punjab National Bank : 142ITR673(Delhi) , it was held that the question to be ascertained from the analysis of the balance-sheet is whether the same forms part of the capital of the company or whether they are just deferred liabilities. If they are deferred liabilities, then they are provisions. They are reserves if they are used in the capital of the company with a view to earn profits.
19. The assessed, in the present case, made a provision in the balance-sheet in respect of the amount debited to its account as lease rent money. The amounts of lease money claimed by the assessed amounting to Rs. 12,02,325 out of Rs. 25,46,717 were not allowed as deduction in the computation of the total income for the purpose of the income-tax. The assessed's contention is that this amount represented a reserve. It was further contended that rule 1 of Schedule II to the Act only excludes that part of the reserve as has been allowed deduction under the I.T. Act. According to the assessed it is immaterial if the entry is described as a provision for liability when in fact and in substance it is merely a description of the reserve. The amount set apart was not and could not be a provision for any known, disputed/contingent liability. Shri Vaish appearing for the assessed contended that it was an error on the part of the assessed to show this amount in the balance-sheet under the head 'Current liabilities and provision' and it should have been shown as a reserve. His contention was that from the terms of the letter dated December 5, 1957, it would be clear that the Government had not decided whether at all the ownership of the assets should be transferred to the assessed and if so on what terms. According to Shri Vaish, the Government could well have decided to take back the machinery or it may have decided to transfer them to the assessed free of cost instead of at their original value as eventually done. thereforee, according to him, till 1965 there was no known liability accrued or contingent on the part of the assessed in respect of such assets and the assessed was merely creating certain funds every year for a specific purpose, viz., to meet the cost of the plant and machinery it may have to acquire in future for the purpose of business and this meant only a creation of a reserve.
20. We are of the opinion that the contention raised by the assessed that the amount in question, in fact, represented a reserve is correct. We have not been shown any liability, present or future, in respect of which the assessed would be called upon to shoulder the responsibility and the allocation, thereforee, would be said to be in the nature of provision. The letter of the Government in pursuance of which the provisions was made shows that the assessed was setting apart certain funds for the purpose of meeting costs of these assets in the event of their ultimate transfer to the assessed. No doubt, a direction given by the Government to the assessed was to debit the cost of production account and not the profit and loss account as was done by the assessed. Further, according to the instructions of the Government, contra-credit was to be given to a reserve account to be opened suitably for the purpose. What the assessed did was not in conformity with the instructions contained in the letter dated December 5, 1957, of the Government. Since no rent was payable to the Government, as per instructions of the Government, no liability to pay arose on the part of the assessed and so the amounts in question could be taken only as a reserve. Having regard to the guidelines laid down by the Supreme Court as well as the provisions of the Companies Act, 1956, we are of the opinion that the amounts in question do constitute a reserve and have to be included in the computation of the capital of the assessed under the Act. Accordingly, we answer the question in the affirmative and in favor of the assessed. We, however, leave the parties to bear their own costs in the circumstances of the case.