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Commissioner of Income-tax, Gujarat-i Vs. Mafatlal Chandulal and Co. Ltd and anr. - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtGujarat High Court
Decided On
Case NumberIncome-Tax Reference No. 3 of 1969
Judge
Reported in[1977]107ITR489(Guj)
ActsSuper Profits Tax Act, 1963 - Schedule - Rules 1 and 3; Income Tax Act, 1961 - Sections 34 and 34(3); Wealth Tax Act, 1957 - Sections 2 and 7(2)
AppellantCommissioner of Income-tax, Gujarat-i
RespondentMafatlal Chandulal and Co. Ltd and anr.
Appellant Advocate J.M. Thakore, Adv.
Respondent Advocate K.H. Kaji, Adv.
Cases ReferredMetal Box Company of India Ltd. v. Their Workmen
Excerpt:
(i) direct taxation - interpretation - rules 1 and 3 of schedule to super profit tax act, 1963 - whether provision made for taxation to be included in capital of company - held, provision made for taxation does not form part of capital of company. (ii) provision for dividend - rules 1 and 3 of schedule to super profit tax act, 1963 - whether amount set apart for dividend form part of capital of company - amount not set apart for meeting present liability - amount set apart for divided to be included in computing capital of company. - - the resolution of the board of directors of the assessee-company appears to have been passed on april 23, 1962, and by the directors' report dated april 23, 1962, the directors recommended that a provision for taxation should be made in the amount of.....b.j. divan, c.j.1. this reference has been made under section 19 of the super profits tax act, 1963, at the instance of the revenue. the two questions which have been referred to us for our opinion are : '(1) whether, on the facts and in the circumstances of the case, the sum of rs. 3,31,069 standing in the provision for taxation account on december 31, 1961, was includible in computing the capital of the company for the purposes of the super profits tax act, 1963 (2) whether, on the facts and in the circumstances of the case, the sum of rs. 2,13,600 standing in the proposed dividend account of december 31, 1961, was includible in computing the capital of the company for the purposes of the super profits tax act, 1963 ?' the facts leading to this reference may now be stated. the.....
Judgment:

B.J. Divan, C.J.

1. This reference has been made under section 19 of the Super Profits Tax Act, 1963, at the instance of the revenue. The two questions which have been referred to us for our opinion are :

'(1) Whether, on the facts and in the circumstances of the case, the sum of Rs. 3,31,069 standing in the provision for taxation account on December 31, 1961, was includible in computing the capital of the company for the purposes of the Super Profits Tax Act, 1963

(2) Whether, on the facts and in the circumstances of the case, the sum of Rs. 2,13,600 standing in the proposed dividend account of December 31, 1961, was includible in computing the capital of the company for the purposes of the Super Profits Tax Act, 1963 ?'

The facts leading to this reference may now be stated. The assessment year under consideration is 1963-64, the relevant previous year being the calendar year ended December 31, 1962. The assessee-company was after the relevant dates amalgamated with Messrs. M.G. Investment Corporation Limited, Bombay, but, for the purpose of this reference, it will be referred to as 'the assessee company'. It was a public limited company. For the calendar year ending on December 31, 1961, it earned a net profit of Rs. 7,15,115. As of January 1, 1961, an amount of Rs. 10,488 had been carried forward from the profit and loss account for the calendar year ending on December 31, 1960. The total disposable amount thus came to Rs. 7,25,603. Out of this aggregate amount, the assessee-company by a resolution of its board of directors transferred a sum of Rs. 3,26,000 to 'taxation provision', a sum of Rs. 2,13,600 to 'proposed dividend' account and an amount of Rs. 1,50,000 to 'general reserve' account. The balance of Rs, 36,003 was carried forward to the next year. The resolution of the board of directors of the assessee-company appears to have been passed on April 23, 1962, and by the directors' report dated April 23, 1962, the directors recommended that a provision for taxation should be made in the amount of Rs. 3,26,000 and after making provision for taxation, Rs. 3,89,115 remained out of the net amount of profits and a sum of Rs. 10,488 thus carried forward in the previous year was added. Thus, Rs. 3,99,603 were available for dividends and other recommendations. The directors recommended that out of the aggregate amount of Rs. 3,99,603, Rs. 1,50,000 should be carried to general reserve, Rs. 2,13,600 should be set apart for payment of dividend to shareholders subject to deduction of tax and the balance amount of Rs, 36,003 should be carried forward to the next year's account. The annual general meeting of the company was held on June 15, 1962, and at that meeting the directors' report and the audited balance sheet and profit and loss account were adopted and the accounts were passed and the declaration of dividend as recommended by the directors was sanctioned. The note appended to the notice convening the annual general meeting mentioned, inter alia, that the dividend, if any, as sanctioned at the general meeting would be paid to those shareholders whose names stood on the registers of the company on May 21, 1962, and the payment was to be made from June 25, 1962, onwards. The question arose before the Income-tax Officer regarding the tax liability under the provisions of the Super Profits Tax Act, 1963, and the question was whether the two items of Rs. 3,26,000 being the provision for taxation and the amount of Rs. 2,13,600 being the amount set apart for the proposed dividend could be included as part of the reserves in the computation of the capital base of the company for standard deduction under rule 3 in the Second Schedule to the Super Profits Tax Act, 1963. The Super Profits Tax Officer rejected the contention of the assessee-company regarding both the claims. The officer held that the amount of Rs. 2,13,600 recommended to be set apart for the proposed dividend was earmarked for distributing it to the shareholders and not for being ploughed back into business or for financial stability which were the essential features of a reserve in any sense of the word because under 'reserve' a part of the profits were to be retained for the strengthening of the finances of a company or for providing a long-term specific purpose. According to the Super Profits Tax Officer the amount of Rs. 2,13,600 represented a part of the profits removed from any channels for the specific purpose of parting with it after a short time and was never to be received back and the Super Profits Tax Officer pointed out that this amount of Rs, 2,13,600 had actually been distributed by the assessee company the shareholders. As regards the company's claim regarding the sum of Rs. 3,31,069 which was set apart as taxation provision, the contention was rejected by the Super Profits Tax Officer on the ground that the amount was set apart for anticipated liability and the money was an outgoing after a short period in the commercial sense of the word and that the said fund was not likely to be retained in the business for any of the purposes for which reserves are created. The assessee-company carried the matter in appeal and the Appellate Assistant Commissioner rejected the contention of the assessee-company regarding the sum of Rs. 3,31,069 on the ground that this amount was kept aside by way of provision for taxation which was clearly distinguishable from reserve. He held that the taxation provision was a charge against profits while a reserve was a portion of the profit normally available for distribution to the shareholders of the company and was not charged against profits. Regarding the amount of Rs.2,13,600 for the proposed dividend, the Appellate Assistant Commissioner rejected the contention of the assessee on the ground that the amount kept aside for proposed dividend did not form part of the reserve of the company inasmuch as the amount was expected to go out of the profits of the company within a few months after the closing of the account.

2. Against the decision of the Appellate Assistant Commissioner the assessee-company carried the matter in further appeal before the Appellate Tribunal the Tribunal held that the directors of the assessee-company, who managed the affairs of the assessee-company, resolved to transfer Rs. 3,26,000 as taxation provision and to transfer Rs. 2,13,600 to the proposed dividend account out of its current year's income and that the conditions requisite for constituting a fund into a reserve within the meaning of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, were satisfied in respect of both the funds. The Tribunal further pointed out that the liability for payment of dividend did not arise till the proposal for payment of dividend was duly approved at the annual general meeting of the company. The Tribunal, therefore, allowed the appeal and directed that both the items, namely, Rs. 3,31,069 and Rs. 2,13,600 should be included in the computation of the capital of the company for the purposes of the Super Profits Tax Act, 1963. Thereafter, at the instance of the revenue, the two questions hereinabove set out have been referred to us for our opinion.

3. We may point out that the Super Profits Tax Act, 1963, is one of the series of pieces of legislation which have been brought on the statute book from time to time by the legislature in India to mop up extraordinary profits made by companies under extraordinary circumstances. Such pieces of legislation were, firstly, the Excess Profits Tax Act, 1940, which was in force during the Second World war, the Business Profits Tax Act, 1947 (hereinafter referred to as 'the Act of 1947'), the Super Profits Tax Act, 1963, with which we are concerned in the present case (hereinafter referred to as 'the Act of 1963'), and the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as 'the Act of 1964'). The decisions under the Act of 1947 have a direct bearing on questions arising under the Act of 1963 and, therefore, we will first refer to the salient features of the Act of 1947.

4. It may be pointed out that the Act of 1947 applied to all assessees like a firm, a Hindu undivided family and a limited company. Section 4 was the charging section and under that section, subject to the provisions of the Act, in respect of any business to which the Act applied, was to be charged, levied and paid on the amount of the taxable profits during any chargeable accounting period, a tax which was referred to in the Act as 'business profits tax' which was to be equal to sixteen and two-thirds per cent, of the taxable profits, for any chargeable accounting period ending on or before the March 31, 1947, and in respect of any chargeable accounting period beginning after March 31, 1947, be equal to any such percentage of the taxable profits as might be fixed by the annual Finance Act. Under section 5 that Act was to apply to every business of which any part of the profits made during the chargeable accounting period was chargeable to income-tax virtue of the provision of sub-clause (ii) of clause (b) of sub-section (1) of section 4 of the Indian Income-tax Act, 1922, or of clause (c) of that sub-section. The rest of the provisions of section 5 of the Act are not material for the purpose of this judgment. Under section 2, sub-section (16), 'Profits' meant profits as determined in accordance with Schedule I. Under section 2, sub-section (17), 'taxable profits' meant the amount by which the profits during a chargeable accounting period exceeded the abatement in respect of that period. 'Abatement' meant, in respect of any chargeable accounting period ending on or before the March 31, 1947, a sum which bore to a sum equal to, in the case of a company, not being a company deemed for the purposes of section 9 to be a firm, six per cent, of the capital of the company on the first day of the said period computed in accordance with Schedule II, or one lakh of rupees, whichever was greater. We are not concerned in the present case with the provisions in definition section 2(1) regarding 'abatement' in the case of a firm or in the case of a Hindu undivided family or in any other case. By section 2, sub-section (3), the term 'business' was to include any trade, commerce or manufacture, or any adventure in the nature of trade, commerce or manufacture, or any profession or vocation the profits of which were chargeable according to the provisions of section 10 of the Indian Income-tax Act, 1922. 'Company' under section 2, sub-section (5), meant a company as defined in the Indian Companies Act, 1913. The other part of the definition is not material for the purposes of this judgment. Schedule I laid down ruled for the computation of profits for the purpose of business profits tax and Schedule II provided rules for computing the capital of a company for purposes of the Act. Rule 1 of the Schedule II to the Act of 1947 provided :

'1. For the purposes of ascertaining the abatement under this Act in respect of any chargeable accounting period, the capital of a company shall be computed in accordance with the following rules.'

5. Under rule 2 as it stood after its amendment by the Business Profits Tax (Amendment) Act, 1948, where the company was one to which rule 3 of Schedule I applied, its capital was to be the sum of the amount of its paid-up share capital and of its reserves in so far as they had not been allowed in computing the profits of the company for the purposes of the Indian Income-tax Act, 1922, diminished by the cost to it of its investments or other property the income from which was not includible in the profits, so far as that cost exceeded any debt for money borrowed by it. In all other cases, the capital was to be the sum ascertained in accordance with sub-rule (1), diminished by the cost to the company of its investments so far as that cost exceeded any debt for money borrowed by it. Explanation to sub-rule (2) stated that a reserve or paid-up share capital brought into existence by creating or increasing (by revaluation or otherwise) any book asset was not capital for the purposes of ascertaining the abatement under the Act in respect of any chargeable accounting period. Thus, under the scheme of rule 2 of Schedule II of the Act of 1947, the amount of the paid up share capital and the amount of its reserve were to be calculated and the amount of reserves was to be the amount in so far as the same had not been allowed in computing the profits of the company for the purposes of the Indian Income-tax Act. We are not concerned with the rest of the provision of that rule. The paid up share capital plus the reserves as mentioned in the above sub-rule were to be the amount on the basis of which the abatement as defined in section 2, sub-section (1), was to be calculated namely, six per cent, of the capital of the company on the first day of the accounting period or one lakh of rupees, whichever was greater. Out of the profits during the chargeable accounting period, the abatement was to be deducted and the balance of the profits were the taxable profits which were charged under section 4 of the Act. Therefore, the greater the amount of the capital base, that is, the aggregate of the paid-up share capital and the reserves, the greater would be the abatement and, therefore, the amount of taxable profits which came within the charge under section 4 would be reduced and this explains the significance of correctly interpreting the word 'reserve' occurring in rule 2 of the Second Schedule to the Act of 1947.

6. Coming now to the Act of 1963, it may be pointed out that the scheme of the Act is broadly the same as that of the Act of 1947. Under section 2, sub-section (5) of the Act of 1963, 'chargeable profits' means the total income of an assessee computed under the Income-tax Act, 1961, for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule. Under section 2, sub-section (9), 'standard deduction' means an amount equal to six per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of fifty thousand rupees, whichever is greater. Thus, in the Act of 1963, instead of the word 'abatement' which was used by the Act of 1947, 'standard deduction' has been used. Under section 4, which is the charging section, subject to the provisions of the Act, there shall be charged to every company for every assessment year commencing on and from the April 1, 1963, a tax (referred to in the Act as the super profits tax) in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the standard deduction, at the rate or rates specified in the Third Schedule. Section 5 provides for relief on occurrence of deficiency. So far as is material for the decision of this judgment is the Second Schedule of the Act. The Second Schedule sets out the rules for computing the capital of a company for the purposes of super profits tax. Under rule 1 of the Second Schedule, subject to the other provisions contained in the Schedule, the capital of a company shall be the sum of the amounts, as on the first day of the previous year relevant to the assessment year, of its paid-up share capital and of its reserve, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922, or under sub-section (3) of section 34 of the Income-tax Act, 1961, and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purposes of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961, diminished by the amount by which the cost to it of the assets the income from which in accordance with clause (iii) or clause (vi) or clause (viii) of rule 1 of the First Schedule is not includible in its chargeable profits, exceeds the aggregate of any money borrowed by it which remains outstanding, and the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under the rule. This is the material provision in so far as the facts of the present case are concerned. We are concerned with the words 'its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purposes of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961'. The standard deduction as shown in the definition section 2, sub-section (9), is to be calculated on the basis of six per cent, of the capital of the company, namely, the paid up capital and its reserves or fifty thousand rupees, whichever is greater. Under section 4 super profits tax at the rate or rates specified in the Third Schedule is to be charged in respect of so much of the chargeable profits of the company for the previous year or previous years as exceed the standard deduction. Thus the revenue is interested in seeing hat the amount of capital is kept at as low a figure as possible so as to net in a larger amount by way of super profits tax whereas an assessee-company would be interested in seeing that its capital base consisting of paid up capital and other reserves is as large as possible so as to get the benefit of a larger amount by way of standard deduction. It may be incidentally mentioned that in the Third Schedule, super profits tax was to be charged on the amount by which the chargeable profits exceed the amount of the standard deduction, at the rates set out therein, namely, for the first four per cent. of the amount of capital as computed in accordance with the Second Schedule, 50 per cent. and on the balance, 60 per cent.

7. The Act of 1964, follows the terminology of the Act of 1963. The 'chargeable profits' under the Act of 1964, section 2, sub-section (5), means the total income of an assessee computed under the Income-tax Act, 1961, for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule. The 'statutory deduction' means an amount equal to 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. Section 4 is the charging section and by section 4, subject to the provisions contained in the Act, there shall be charged on every company for every assessment year commencing on and from the April 1, 1964, a tax (in this Act referred to as the 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. The Second Schedule, as under the scheme of the Acts of 1947 and 1963, sets out the rules for computing the capital of a company for the purpose of surtax. Under rule 1 of the Second Schedule, subject to the other provisions contained in the 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) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922, or under sub-section (3) of section 34 of the Income-tax Act, 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 purposes of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961;

(iv) its debentures, if any; and

(v) any moneys borrowed by it from Government or the Industrial Finance Corporation of Indian or the Industrial Credit and Investment Corporation of India or any other financial institution which the Central Government may notify in this behalf in the Official Gazette or any banking institution (not being a financial institution notified as aforesaid) or any person in a country outside India :

Provided that such moneys are borrowed for the creation of a capital asset in India and the agreement under which such moneys are borrowed provides for the repayment thereof during a period of not less than seven years. Thus, rule 1 of the Second Schedule of the Act of 1964 provides a much more elaborate and detailed break-up of the capital of a company on the basis of which the standard deduction is to be computed as defined in section 2, sub-section (8), of the Act. Various percentages for the rates of surtax have been laid down in the Third Schedule but they are not necessary for the purposes of this judgment.

The above examination of the provisions of all the three Acts, namely, the Act of 1947, the Act of 1963 and the Act of 1964, will show that in every case, along with the paid up capital, the reserve play a very material part in the computation of the capital of the company and there have been several decisions of the Supreme Court, some under the Act of 1947 and one under the Act of 1964, which throw light not the concept of reserves in the context of these more or less similar taxation statutes. The common feature of all the three statutes is that a special levy of tad on chargeable profits computed in accordance with the provisions of the respective Acts has been provided for and in the charging section the computation of abatement or standard deduction plays a very material part and, therefore, the whole concept of reserves has to be considered. In the instant case also, as indicated by the questions which have been referred to us, the question that we have to decide is, whether the amount of Rs. 3,31,069 being the provision for taxation liabilities and the amount of Rs. 2,13,600 being the amount set apart by the directors for distribution as dividends come within the definition of reserves for the purposes of computation of the capital of the assessee-company for the assessment year 1963-64. It may be pointed out that under the provisions of these three Acts as set out in the respective Second Schedule to the Act in question, it is the amount of the paid up capital and reserve as at the date of the commencement of the previous year that would decide the total figure of capital and reserves for computation of the capital. The previous year of the assessee before us was the calendar year 1962 and it is, therefore, obvious that the paid up capital and reserves as at the commencement of the previous year, namely, calendar yea 1962, would be what is shown in the balance-sheet of the company as of December31, 1961, because what is shown in the balance-sheet as of December 31, 1961, would be the opening amounts of paid up capital and reserves as of January 1, 1962.

8. In Commissioner of Income-tax v. Century Spg. and Mfg. Co. Ltd. : [1953]24ITR499(Bom) , the Supreme Court was concerned with the provisions of the Act of 1947, and the facts of the case were as follows. For the year ending December 31, 1945, the profit of the assessee-company, whose accounting year was the calendar year, was a certain sum according to the profit and loss account. After making provision for depreciation and taxation, the balance of Rs. 5,08,637 was carried to the balance-sheet. This sum was not allowed in computing the profits of the assessee for purposes of income-tax. In February, 1946, the directors recommended that out of that amount a sum of Rs. 4,92,426 should be distributed as dividend and the balance of Rs. 16,211 was to be carried forward to the next year's account. This recommendation was accepted by the shareholders in their meeting on April 3, 1946, and the amount was shortly afterwards distributed as dividend. In computing the capital of the assessee-company on April 1,1946, under the Act of 1947, the assessee claimed that the sum of Rs. 5,08,637 and the profit earned by it during the period January 1, 1946, to April, 1 1946, should be treated as 'reserves' for the purpose of rule 2(1) of Schedule II of that Act. The High Court held that the sum of Rs. 5,08,637 must be treated as a reserve for the purpose of rule 2, but the profits made by the assessee during the period January 1, 1946 to April 1, 1946, could not be included in the reserves. The revenue took the matter in appeal to the Supreme Court and the decision of the Supreme Court was that the sum of Rs. 5,08,637 and the profit earned by the assessee during the period January 1, 1946, to April 1, 946, did not constitute reserves within the meaning of rule 2(1) of Schedule II of the Act of 1947. Thus, the main question before the Supreme Court was as to the meaning of the word 'reserves' occurring in rule 2(1) of Schedule II of the Act of 1947. Ghulam Hasan J., delivering the judgment of the Supreme Court, pointed out at page 503 of the report that two essential characteristics must be present before the assessee can avail himself of the benefit of the rule, namely, that the amount should not have been allowed in computing the profits of the company for the purposes of the Income-tax Act and that it should be a reserve as contemplated by the rule. It was further pointed out that the term 'reserve' is not defined in the Act and, therefore, the court referred to the ordinary natural meaning as understood in common parlance. The dictionary meaning of the word 'reserve' was referred to and different meaning as set out in the Oxford Dictionary and Webster's New International Dictionary were set out in the judgment and then it was observed - See : [1953]24ITR499(Bom) :

'What is the true nature and character of the disputed sum, must be determined with reference to the substance of the matter and when this is borne in mind, it follows that on the April 1, 1946, which is the crucial date, the sum of Rs. 5,08,637 could not be called a 'reserve' for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on the February, 1946, the directors clearly earmarked it for distribution as dividend and did not choose to make it a reserve. Nor did the company in its meeting on the April 3,1946, decide that it was a reserve. It reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind.' On the January, 1946, the amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The reserve may be a general reserve on specific reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind.'

9. It was pointed out by the Supreme Court in this case that on April 1, 1946, which was the commencement of the chargeable accounting period, there was merely a recommendation by the directors that the amount in question should be distributed as dividend. Far from showing that the directors had made the amount in question a reserve, it showed that they had decided to earmark it for distribution as dividend. A passage from the judgment of the Bombay High Court is set out and criticised as a statement due to a misapprehension as to the real position.

10. The Supreme Court then observed - See : [1953]24ITR499(Bom) :

'The directors had no power to distribute the sum as dividend. They could only recommend, as indeed they did, and it was up to the shareholders of the company to accept that recommendation in which case alone the distribution could take place. The recommendation was accepted and the dividend was actually distributed. It is, therefore, not correct to say that the amount was kept back. The nature of the amount which was nothing more than the undistributed profits of the company remained unaltered. Thus the profits lying unutilized and not specially set part for any purpose on the crucial date did not constitute reserves within the meaning of Schedule II, rule 2(1).'

11. The Supreme Court referred to the provisions of the Companies Act and regulation 99 of the First Schedule in Table A and observed at page 505

'The regulation suggests that any sum out of the profits of the company which is toe be made as a reserve or reserves must be set aside before the directors recommend any dividend. In this case, the directors while recommending dividend took no action to set aside any portion of this sum as a reserve or reserves. Indeed, they never applied their mind to this aspect of the matter. The balance-sheet drawn up by the assessee as showing the profits was prepared in accordance with the provisions of the Indian Companies Act. These provisions also support the conclusion as to what is the true nature of a reserve shown in a balance-sheet.'

Thus, in this case, the Supreme Court has considered the question of reserves with reference to the substance of the matter and it has been emphasized that substances of the matter and not the form is the determining factor. Moreover, it is emphasized that before any particular amount can be treated as reserve, it must have been set apart or kept apart by a person with authority to do so and it must further be pointed out that the provisions of the Companies Act, 1913, which was then in force and regulation 99 of the First Schedule of Table A were referred to for the purpose of reinforcing its conclusions as to what is the true nature of a reserve shown in a balance-sheet.

12. In First National City Bank v. Commissioner of Income-tax : [1961]42ITR17(SC) the question once again arose before the Supreme Court regarding the question of reserves under the Act of 1947. The assessee in that case was a non-resident bank incorporated under the National Bank Act of the United States of America and it was following the system of accounting adopted by American banks. This system conformed to the instructions contained in the Treasury Rules of the USA and under those rules the assessee set aside and transferred the net profits of each year, after provision for expenses, taxes, dividends and reserves, to an account headed 'undivided profits'. The statute under which an allocation had to be made under that account treated 'undivided profits' as part of the capital funds of the bank. By his letter the Deputy Controller of Currency Washington, affirmed that in the USA the 'undivided profits' actually represented a part of the capital funds of the bank and was included to ascertain the adequate of capital of the bank. When losses occurred it was the usual practice in many banks to charge them against the 'undivided profits' account. The profits transferred to the 'undivided profits' account were available for continuous future use in the business amounts designed 'undivided profits' should be treated as reserves and added to the capital for the purposes of abatement under the Act of 1947. The Supreme Court, on these facts, held that, in their very nature, the 'undivided profits' were accumulation of residue on hand at the end of the year of successive periods of accounting an these amounts were, by the prevailing accounting practice and the Treasury directions, regarded as a part of the capital fund of the banking company. The creation and maintenance of the item known as 'undivided profits' was a requirement of the Treasury rules which were made under the statute and, therefore, it could not be said that the amount of 'undivided profits' in the balance-sheet was not allocated as a result of either a resolution of the directors, accepted by the shareholders, or on account of the requirements of the law. The Supreme Court, therefore, held that the amount designated as 'undivided profits' was a part of the reserves and had to be taken into account when computing the capital and reserves under rule 2(1) of Schedule II to the Act of 1947. In coming to its decision in this case, the Supreme Court applied the principles laid down in Century Spg. & Mfg. Company's case : [1953]24ITR499(Bom) of the report Kapur J. pointed out that the amounts credited to the 'undivided profits' account were by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company. The Supreme Court referred to the decision of the Supreme Court of America in Fidelity Title and Trust Co. v. United States, 66 L ED 953, and there the Supreme Court of America had held that 'undivided profits' were taxable as being part of the capital employed in the business of the bank. The following passage from the judgment of Mr. Justice Brandeis, delivering the opinion of the Supreme Court of America, was considered - See : [1961]42ITR17(SC) :

'The Act declares that 'in estimating capital surplus shall be included', and that the 'annual tax shall in all cases be computed on the basis of the capital and surplus for the preceding fiscal year'........ As it is the use or employment of capital in banking, not mere possession thereof by the banker, which determines the amount of tax, the fact that a portion of the capital so used or employed is designated 'undivided profits' is of no legal significance.'

13. The Supreme Court of India in the case of First National City Bank : [1961]42ITR17(SC) pointed out that the term 'undivided profits' simply followed a bank accounting nomenclature used in the United States to designate profits set aside, after provisions for expenses and taxes, dividends and reserves, for continuous future use in the business of the bank and it bore a close, if not identical, relationship to the earned surplus account of an industrial corporation. The Supreme Court further pointed out that the creation and maintenance of the items known as 'undivided profits' was a requirement of the Treasury rules which were made under the Statute and, therefore, it could not be said that the amount of undivided profits in the balance-sheet was not allocated as a result of either a resolution of the directors, accepted by the shareholders or on account of the requirements of the law. The Supreme Court in the First National City Bank's case : [1961]42ITR17(SC) observed :

'It was held that the true nature and character of a sum disputed as reserve was to be determined with reference to the substance of the matter.'

14. The following passage : [1961]42ITR17(SC) , inter alia, from the decision of Ghulam Hasan J. in Century Spg. Mfg. Company's case : [1953]24ITR499(Bom) was cited :

'A reserve in the sense in which it is used in rule 2 can only mean profit earned by a company and not distributed as dividend to the shareholders but kept back by the directors for any purpose to which it may be put in future.....'

15. Applying the test laid down in Century Spg. Mfg. Company's case : [1953]24ITR499(Bom) , the Supreme Court held in the case of First National City Bank : [1961]42ITR17(SC) that it could not be said that the amount was not 'reserve' within the meaning of the rule. As is shown by the instructions under section 5211 of the Revised Statute of the United States and the letter of the Deputy Controller referred to above, the appellant bank was required to keep a certain sum of money under the head 'undivided profits' and that was an integral part of the capital Structure. Under these circumstances it would be erroneous not to treat the amount of 'undivided profits' as a part of the capital fund. This decision of the Supreme Court indicates that the requirements of the law governing the assessee have to be taken into consideration and the accounting practice followed by the bank in accordance with well recognised principles of accounting and the prevailing accounting practice has to be borne in mind when deciding whether a particular sum kept back by the directors for any purpose of distribution in future amounts to 'reserve' or not.

16. In Commissioner of Income-tax v. Standard Vacuum Oil Company : [1966]59ITR685(SC) the same question of 'reserve' within the meaning of rule 2 of Schedule II of the Act of 1947 was again considered by our Supreme Court. In this case, the assessee was a non-resident company incorporated in Delaware in the U.S.A. with the object of taking over the assets of two other companies, the Socony Vacuum Oil Company and the Standard Oil Company (New Jersey), in consideration of the transfer of assets valued in their books at $97,715,701 and $46,767,397, respectively, allotted to each company 49,995 shares of $100 each and to Socony Vacuum Oil Company serial bonds of the value of $13,093,300. The remaining ten shares of the share capital of the assessee-company were divided equally between the two companies for cash. The assessee-company entered in its books of account the book value of the assets taken over from the companies and the excess of the net value of the assets transferred over the par value of the stock issued and the serial bonds was entered in the account styled 'capital paid in surplus'. Later, the serial bonds issued to the Socony Vacuum Oil Company were redeemed. After some adjustments the 'capital paid in surplus' account was reduced to $117,561,317 and thereafter 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 capital 'earned surplus'. The balance of 'earned surplus' was $29,557,597 at the end of 1945. It progressively increased thereafter and, by the end of 1948, stood at $73,766,592. The questions were, (i) whether the 'capital paid in surplus' was a premium, realised from the issue of share within the meaning of the rule 3 of Schedule II to the Act of 1947; and (ii) whether the 'capital paid in surplus' and the 'earned surplus' were reserves within the meaning of the rule 2(1) of the Second Schedule. It was held by the Supreme Court that when shares were issued to the public at a premium, ordinarily premium at a uniform rate would be charged from all applicants for shares. But that was not because the law contained any prohibition against charging differential premiums. On principle there was no objection to the charging of varying rates of premiums for shares issued under a single resolution, if all the parties concerned agreed. It was further held that the difference between the book value of the assets transferred and the par value of capital stock issued was 'premium' realised from the issue of shares within the meaning of rule 3. What is really important for the purpose of this judgment is that it was held that it was not necessary that a reserve admissible in the computation of capital should be one built out of profits. Reserves built up from sources other than profits were also admissible for inclusion in capital under rule 2(1). On the facts of that case 'capital paid in surplus' was also held to be 'reserve' within the meaning of rule 2. And, lastly, in its ordinary meaning, the expression 'reserve' meant something specifically kept apart for future use or for a specific action. The Supreme Court held that the accumulated profits of the assessee-company 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 to designate a fund to be utilised for the purposes of the business of the assessee-company, and the amounts so allocated were used in subsequent years in the business. The account in which this amount was carried also retained its identity year after year. Therefore, the 'earned surplus' could not be regarded as mere unallocated profits but represented 'reserves' within the meaning of rule 2. In this case the Supreme Court followed the earlier decision in First National City Bank's case : [1961]42ITR17(SC) and explained the position in Century Spg. & Mfg. Company's case : [1953]24ITR499(Bom) of : [1966]59ITR685(SC) , Shah J., as he then was, delivering the judgment of the Supreme Court, pointed out that it was not necessary that the reserve should be built up out of profits. It was laid down that the reserves which were not built out of profits could not be excluded from the operation of rule 2(1). As regards 'earned surplus', it was observed by the Supreme Court that that amount had not been called 'reserve' but if it was truly a reserve, it must be taken into account in the computation of capital. In considering this question, it was necessary to note certain special features of the system of accounting obtaining in the United States of America. It was pointed out that by setting apart funds as 'earned surplus' it was intended to designate a fund which was to be utilised for the purpose of the business of the assessee. Such a fund may be regarded according to the Indian practice as 'general reserves'. After referring to the decision of the Supreme Court in Century Spg. & Mfg. Company's case : [1953]24ITR499(SC) , Shah J. observed at page 697 of : [1966]59ITR685(SC) :

'The court was dealing in that case with the accounts of an Indian company, the balance-sheet of which was prepared according to the provisions of the Indian Companies Act, 1913. Regulation 99 of the First Schedule, Table A, required that reserves must be set apart before the directors recommended any dividend, but out of the profits of the company no amount was set apart towards reserves before the directors recommended payment of dividend to the shareholders. The identity of the amount remaining on hand at the foot of the profit and loss account was not preserved. It is on these facts that the court held that there was no allocation of the amount to reserve and from the mere fact that it was carried forward in the account of the next year and ultimately applied in payment of dividend, it could not be said to be specifically set apart for any purpose at the relevant date, i.e., the end of the year of account.'

At page 698 of the report, Shah J. observed :

'In its ordinary meaning the expression 'reserves' means 'something specifically kept apart for future use or for a specific occasion'.'

In this case also it may be noted that the Supreme Court took into consideration the accounting practice which was followed by the company and also the requirements of the statute which it had to follow in its account keeping practice. The substance of the matter was looked at and the test which was applied in the light of the earlier decisions was of something specifically set apart for future use or for a specific occasion.

17. In Commissioner of Income-tax v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) the Supreme Court was concerned with the provisions of the Act of 1964. In that case, out of the profits of the company for the accounting period ending March 31, 1963, the directors of the company appropriated the following amounts towards reserves on August 8, 1963 :

(i) Rs. 2,56,000 as plant modernisation and rehabilitation reserve; (ii) Rs. 1,00,000 as loss repatriation reserve; and (iii) Rs. 89,557 as development rebate reserve. The question was whether these amounts could be included in computing the capital of the respondent as on April 1, 1963, under rule 1 of Schedule II to the Act of 1964, for the purpose of the statutory deduction for the assessment year 1964-65. The department contended that since the appropriations were made on August 8, 1963, they could not be treated as components of capital as on the first day of the previous year, viz. April 1, 1963. On these facts, the Supreme Court, rejecting contention of the department, held that the determination of the directors to appropriate the amounts to the three items of reserve on August 8, 1963, had to be related to April 1, 1963, viz., the beginning of the accounts for the new year, and had to be treated as effective from that day. The three items had to be added to other items for the computation of the capital of the respondent as on April 1, 1963, under rule 1 of Schedule II of the Act of 1964. At page 569 of the report, Mitter J., delivering the judgment of the Supreme Court, observed :

'The sole contention on behalf of the appellant is that these appropriations having been made on the August 8, 1963, could not be treated as components of capital 'as on the first day of the previous year', i.e., the first of April, 1963, in terms of rule 1 to the Second Schedule. The learned Solicitor-General submitted that these could only be taken into consideration in the subsequent year commencing on the April 1, 1964, on the ground that on the April 1, 1963, they only formed a part of the mass of undistributed profits, no portion of which had been earmarked or set apart for any particular purpose. In our view, this is not the correct way of appreciation of the action of the directors.

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 March 31, 1963. If it was reasonably practicable to male up the accounts up to the March 31, 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 August 8, 1963, must be related to the April 1, 1963, i.e., the beginning of the accounts for the new year and must be treated as effective from that day.'

In the case of Commissioner of Income-tax v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) the Supreme Court approved of the earlier decision of the Bombay High Court in Commissioner of Income-tax v. Aryodaya Ginning and . [1975] 31 ITR 145 and disapproved of the judgment of the Madras High Court in Commissioner of Income-tax v.Vasantha Mills Ltd. : [1957]32ITR237(Mad) . The Madras High Court had dissented from the view expressed by the Bombay High Court and the question before the Bombay High Court was whether a reserve could be created with retrospective effect. The learned judges of the Bombay High Court were of the view that the resolution passed by the board of directors had a retrospective effect, inasmuch as it referred to the profits of the year ending on December 31, 1948, the appropriations to be made in the balance-sheet as on December 31,1948. The Bombay High Court in Aryodaya Ginning and .'s case : [1957]31ITR145(Bom) observed that when one looked at the balance-sheet of the year ended December 31, 1948, the amounts mentioned were shown respectively in the reserve fund and the dividend reserve fund and the shareholders, by passing a resolution on June 27, 1949, did not decide that these amounts should constitute reserves as from that date but they accepted the recommendation of the directors that these amounts should constitute reserves as of December 31, 1948.

18. In our opinion, the approval of the Supreme Court to the decision of the Bombay High Court in Aryodaya Ginning and .'s case : [1957]31ITR145(Bom) and disapproval of the decision of the Madras High Court in Vasantha Mills Ltd.'s : [1957]32ITR237(Mad) is very significant and important.

19. In Commissioner of Income-tax v. Aryodaya Ginning and Mfg. Co. Ltd. : [1957]31ITR145(Bom) the limited company made up its accounts at the end of December every year. For the year ending December 31, 1948, the directors made certain appropriations of the profits of that year and the profits brought forward from the previous year, and allocated certain amounts to the reserve fund and the dividend reserve fund. At a general meeting held on June 27, 1949, the shareholders of the company accepted the recommendations of the directors and passed the balance-sheet. In the assessment of the company to business profits tax for the chargeable accounting period January 1, 1949, to March 31,1949, under the Act of 1947, the company claimed that the amounts allocated to the reserve fund and the dividend reserve fund should be taken into account in computing its capital for the purpose of abatement, inasmuch as these reserves appeared in the balance-sheet as of December 31, 1948. The income-tax authorities contended that, as the reserves were not sanctioned by the shareholders till June 27, 1949, they could not be treated as reserves for the chargeable accounting period of January 1, 1949, to March 31, 1949. On these facts, the Division Bench of the Bombay High Court consisting of Chagla C.J. and Tendolkar J. held that, as the shareholders had by their resolution of June 27, 1949, decided not only that these amounts should constitute reserves but also that these amounts should constitute reserves of the company as of December 31, 1948, and the profits out of which these amounts were reserved were profits made by the company before January 1, 1949, and the reserves were in existence on that date and could have been utilised for the working of the company as much as the capital, during the chargeable accounting period in question, the amounts transferred to the reserve funds must be taken into account in computing the capital for the purpose of allowing abatement under the Act for the relevant accounting period, i.e., from January 1, 1949, to March 31, 1949. The decision of the Supreme Court in Commissioner of Income-tax v. Century Spg. and Mfg. C. Ltd. : [1953]24ITR499(SC) was distinguished by Chagla C.J., delivering the judgment of the Division Bench in the following terms - See : [1957]31ITR145(Bom) :

'This amount (Rs. 5,08,637 in Century Spinning and .,'s case : [1953]24ITR499(SC) was earmarked by the directors for distribution as dividend, it had never been set apart as reserve, and the view taken by this court, which view was not accepted by the Supreme Court, was that as that amount constituted undistributed profits they must be looked upon as having been set apart till they were actually appropriated for the purpose of payment of dividend. As we have pointed out, that view was not accepted by the Supreme Court and the Supreme Court held that nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination and the fact that that amount constituted a mass of undistributed profits could not automatically make it a reserve. Therefore, it will be noticed that in the case before the Supreme Court there was no reserve at all and therefore no question arose as to when the reserve could be considered as having been constituted...... In the case before us we have this distinguishing feature that certain amounts have been earmarked by the directors as reserve, and the shareholders have accepted the recommendation and passed a resolution at the general meeting.

On principle, too, the contention put forward by the Commissioner sees to us to be untenable. The business profits tax gives to a business-man certain abatement in respect of capital utilised by the company, it also gives abatement in respect of reserves because reserves are looked upon as standing on the same footing as capital. If that be the principle underlying taxation under the business profits tax, then it is difficult to understand why a businessman should not get the benefit of the reserves actually utilised by the company for the working of the company. In this case the profits were made at the end of December 31, 1948, and from January 1, 1949, the reserves were in existence and could be utilised for the working of the company as much as the capital. If that be so, the mere fact that the shareholders passed a resolution at a later date cannot affect the merits of the question or the right of the assessee-company to get the benefit of the abatement provided by the business profits tax.'

20. As we have stated earlier, the significance of this decision in Aryodaya Ginning and Mfg. Co. Ltd.'s case : [1957]31ITR145(Bom) is for the purpose facturing Co. Ltd.'s case : [1953]24ITR499(Bom) and the retrospective effect which the Bombay High Court gave to the resolutions of the board of directors and of the shareholders in the general meeting. The significance of this decision in Aryodaya Ginning and Mfg. Co. Ltd.'s case : [1957]31ITR145(Bom) is that it was approved by the Supreme Court in Commissioner of Income-tax v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) . It is, therefore, in the light of these different decisions of the Supreme Court having a direct bearing on the Acts of 1947 and 1964, that we will have to consider the question arising for our decision in the instant case.

21. Having noted these different decision of the Supreme Court and two of the decisions, one of the Bombay High Court and another of the Madras High Court, which have been considered by the Supreme Court in Commissioner of Income-tax v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) , we will now go on to consider the decisions of the different High Courts which have also considered cases arising under the Act of 1947, or the Act of 1963 or the Act of 1964. It must be pointed out that real help can be derived only from those decisions which have been delivered by the different High Courts after the latest of the Supreme Court decisions on this point, namely, in Commissioner of Income-tax v. Mysore Electrical Industries : [1971]80ITR566(SC) was delivered by the Supreme Court. The learned Advocate-General on behalf of the revenue has drawn our attention to the following decisions of the different High Courts.

22. In Commissioner of Income-tax v. Bank of Bihar Ltd. : [1953]24ITR9(Patna) , the Patna High Court was concerned with the Act of 1947 and in that case the Patna High Court dissented from the view of the Bombay High Court in Commissioner of Income-tax v. Century Spinning and . [1951] 20 ITR 260 . As pointed out earlier, the Supreme Court reversed the decision of the Bombay High Court in Commissioner of Income-tax v. Century Spinning and . : [1953]24ITR499(Bom) . The decision of the Patna High Court proceeded upon the footing that unless the directors apply their mind to the question and unless they make appropriations of the balance to the payment of dividends or to building up reserves it cannot be said that any portion of the amount of balance in the profit and loss account can be treated as 'reserve or reserves' for the purpose of computing the amount of capital under rule 2 of Schedule II of the Act of 1947.

23. In Indian Steel & Wire Products Ltd. v. Commissioner of Income-tax : [1955]27ITR436(Cal) , the Calcutta High Court was concerned with the Act of 1947. It followed the Supreme Court decision in Century Spinning and .,'s case : [1953]24ITR499(Bom) and held that as the company had not indicated the manner of the disposal or the destination of the balance of the profits of the previous year as well as the profits of the year under consideration, neither amount could be considered to be a 'reserve' for the purpose of rule 2(1) of Schedule II to the Business Profits Tax Act. If the surplus is simply carried forward without the persons in requisite authority allocating it to any particular purpose of capital computation under the Business Profits Tax Act, according to this decision of the Calcutta High Court.

24. In Indian Steel & Wire Products Ltd. v. Commissioner of Income-tax : [1958]33ITR579(Cal) , the Calcutta High Court again referred to the decision of the Supreme Court in Century Spinning and .,'s case : [1953]24ITR499(Bom) and held that advance payments of tax made under section 18A of the Indian Income-tax Act, 1922, are payments on account, made under the compulsion of a statute, towards the discharge of an instant liability for liquidating a charge, the precise measure of which is to be determined at a later date; such payments cannot be regarded as payments made by way of creating a reserve. The disposing power of the company over the moneys paid as advance tax is completely and irretrievably lost and it is not possible to say that the moneys are still lying as a part of the company's reserve. In this case of Indian Steel and Wire Products Ltd. : [1958]33ITR579(Cal) , there was no question of any money being specifically set apart by the company out of its profits or from out of its other funds available to it for any specific purpose of the company itself.

25. In Commissioner of Income-tax v. Rohit Mills Ltd. : [1965]58ITR854(Guj) , a Division Bench of this High Court was concerned with the Act of 1947, and following the observations of the Calcutta High Court in Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax : [1955]27ITR436(Cal) and also of the Supreme Court in Century Spinning and .,'s case : [1953]24ITR499(Bom) , this court held that for the purpose of computing the capital of a company under the Business Profits Tax Act, 1947, taxation reserves (shown on the credit side of the balance-sheet) should not be reduced by the amount of taxes paid (shown on the debit side of the balance-sheet). The amounts of advance tax paid should not, in any event, be deducted from the 'taxation reserve fund'. A reserve is created only out of the whole or a part of the surplus profits as they are found to be in the hands of the company at the end of the year, and advance payments of tax under section 18A of the Income-tax Act are payments on accounts and cannot be treated as part of the Super Profits Tax Act for the purpose of the Business Profits Tax Act. Thus, this decision stands on practically the same lines as the decision in Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax : [1958]33ITR579(Cal) , which was also referred to by this High Court.

26. In Aluminium Industries Ltd. v. Commissioner of Income-tax : [1968]68ITR125(Ker) the Kerala High Court was concerned with the Act of 1963, and following the observations of the Supreme Court in Century Spinning and .,'s case : [1953]24ITR499(Bom) and in Standard Vacuum Oil Company's case : [1966]59ITR685(SC) as well as in First National City Bank's case : [1961]42ITR17(SC) , it was held that a reserve may be a general reserve or a specific reserve, but in order to constitute a reserve there must be a clear indication to show that it was a reserve either of the one or the other kind. A mass of undistributed profits is not a reserve, even though it is shown in the balance-sheet as a reserve. It may be pointed out that this decision of the Kerala High Court is contrary to what was held by the Bombay High Court in Aryodaya Ginning and .,'s case [1975] 31 ITR 145 which, as observed above, was subsequently approved by the Supreme Court in Commissioner of Income-tax v. Mysore Electrical Industries Ltd.,'s case : [1971]80ITR566(SC) .

27. In Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) the Allahabad High Court was concerned with the Act of 1963, and after considering the different decisions which were referred to above and particularly the decisions of the Supreme Court in Century Spinning and .,'s case : [1953]24ITR499(SC) , Standard Vacuum Oil Company's case : [1966]59ITR685(SC) and First National City Bank's case : [1961]42ITR17(SC) , the Division Bench of the Allahabad High Court held that the term 'reserve' in rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, means a sum specifically kept apart for future use or application in a future contingency which is anticipated; a fund which is created and maintained for the purpose of being drawn upon, in future. The reservation must be effected by someone having authority to do so; and it must be of a specific sum for a specified use and where it arises out of the surplus profits of a company, it should be set apart before the distribution of dividends to the shareholders. The provision for bonus, the provision for taxation and the provision for proposed dividend by a company are entitled to be treated as 'reserves' for the purposes of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, and they should be included in the computation of capital under that provision where there was not dispute that the three items had actually been debited to the assessee's profit and loss account and had not allowed as a deduction for the purpose of income-tax assessment.

28. In Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) the Allahabad High Court was concerned with the Act of 1963 and following the principle that, to constitute a 'reserve', the amount must be specifically kept apart for future use or for a specific occasion, it held that the amounts of proposed dividends, provisions for taxation, credit balance of profit and loss account and depreciation reserve, being excess of book depreciation over income-tax allowed depreciation, could not be considered as representing 'reserves' and none of these four items could be said to represent 'reserves' for the purpose of computation of capital under the Act of 1963. The Allahabad High Court held that none of the first three items which were under consideration before it was set apart as a reserve for any purpose and those three items fell within the rule laid down in the Century Spinning and .,'s case : [1953]24ITR499(SC) . The fourth item, which was described as depreciation reserve was the excess of book depreciation over the income-tax allowed depreciation. There was no evidence that the amount was set apart for a future use, and, having regard to the test laid down by the Supreme Court in the decisions cited, it could not be treated as a reserve.

29. In Commissioner of Income-tax v. British India Corporation (P.) Ltd. : [1973]92ITR38(All) before the Allahabad High Court, for the purposes of assessment of super profits tax, the assessee claimed that a number of accounts represented reserves which also should be taken into account while determining the 'standard deduction'. It was held that when an amount is set apart for a future liability, it is called a reserve and when it is set apart to meet an existing liability, it is called a provision. The Allahabad High Court held that it was rightly held by the Tribunal in that case that capital reserve, stocks and stores reserves, bad and doubtful debts reserves, obsolescence reserves, loans and insurance reserves, and investment reserves were to be included in the computation of capital, but the Tribunal was not right in including forfeited money reserve. The assessee had been transferring to this account dividends which had not been collected by the shareholders after they had been declared, and as and when the shareholders made a claim, made payments and debited the same to this account. This account, therefore, represented a provision in respect of an existing liability of the company and, as such, it could not be held to be a reserve.

30. In Commissioner of Income-tax v. Periakaramalai Tea & Produce Co. Ltd. : [1973]92ITR65(Ker) , the Kerala High Court was concerned with the Act of 1964 and the question was of reserve for retirement gratuity and whether that reserve could be included in the computation of capital for the purpose of the Act of 1964. It was held that where a liability has actually arisen, though the quantum of the liability has not yet been determined, a provision to meet such present liability is not a provision by way of reserve. A fund created for payment of retirement gratuity to the employees of a company is not for any commitment which has already arisen or payment of which has fallen due but is only a provision in regard to gratuity which may have to be paid to the employees as and when the liability may arise in future. The fund so created is 'other reserve' within the meaning of rule 1 of the Second Schedule to the Act of 1964 and should be taken into account in computing the capital of the company for the purposes of the Act.

31. We may point out that as regards the money set apart in the gratuity reserve for payment to workers under a gratuity scheme, there is a direct decision of the Supreme Court in Standard Mills Co. Ltd. v. Commissioner of Wealth-tax : [1967]63ITR470(SC) . It is true that the Supreme Court in that case was concerned with the Wealth-tax Act and particularly sections 2(m) and 7(2). In that case the Supreme Court held that the liability of the assessee to pay gratuity to its employees on determination of employment of the employee was determined by death, incapacity, retirement or resignation; the liability did not exist in praesenti. The amount claimed could be deducted as a 'debt' in computing the net wealth of the assessee. Nor could such a contingent liability be taken into account in computing the net value of the assets of the assessee under section 7(2)(a) of the Wealth-tax Act, 1957.

32. However, in view of the clear distinction made by the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC , between a provision and a reserve as known to accountancy practice, it must be held that in the light of the Standard Mills. Co. Ltd.,'s case : [1967]63ITR470(SC) funds set apart for payment of gratuity to the workers will form part of the reserves of the company. Shelat J., delivering the judgment of the Supreme Court in Metal Box Company of India Ltd.,'s case : (1969)ILLJ785SC , observed at page 67 :

'The next question is whether the amount so provided is a provision or a reserve. 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 P. & L. 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..... 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 provided for any known liability of which the amount cannot be determined with substantial accuracy is a provision.'

Thus if amount is set apart to meet a present liability or liability which is known at present, it would be a provision as distinguished from a reserve. If, however, the amount is set aside out of profits or other surpluses and is not designed to meet a liability known to exist at the date of the balance-sheet, it would be a reserve. Since according to the decision of the Standard Mills Co. Ltd.,'s case : [1967]63ITR470(SC) the liability for payment of gratuity to the employees of a concern is to in respect of a liability in praesenti since such a liability does not exist in praesenti, it would be a reserve and to that extent, with respect, we agree with the conclusion of the Kerala High Court in Commissioner of Income-tax v. Periakaramalai Tea and Produce Co. Ltd.,'s case : [1973]92ITR65(Ker) .

33. In Commissioner of Income-tax v. Indian Steel Rolling Mills Ltd. : [1973]92ITR78(Mad) the Madras High Court was also concerned with the question of reserve created for the purpose of payment of gratuity and there it was held that the amounts set apart for payment of gratuity, a contingent and future liability, and which have been used for the purpose of the business of the company, should be treated as a 'reserve' within the meaning of rule 1 of the Second Schedule to the Act of 1963, in determining the 'standard deduction' to which a company is entitled and such reserve need not be a capitalised or tied up reserve. Similarly, the excess provision for taxation which was available for use by the company in its business is a reserve with the meaning of the Act.

34. It is true, as pointed out by Hegde J., speaking for the Supreme Court in Bombay Dyeing and . v. Commissioner of Wealth-tax : [1974]93ITR603(SC) at page 604, the decision in Metal Box Company's case : (1969)ILLJ785SC was a decision rendered under the Payment of Bonus Act. However, we are referring to that judgment for the purpose of pointing out what the standard commercial accountancy practice is in connection with reserves and provisions and the distinction between provision and reserve according to the standard commercial accountancy practice as recognised by the Supreme Court in this connection. As observed earlier, according to the Supreme Court in Commissioner of Income-tax v. Standard Vacuum Oil Company : [1966]59ITR685(SC) , the accounting practice followed by the company and the requirements of the statute which its has to follow in its account keeping practice have to be taken into consideration. The substance of the matter has also to be looked at.

35. It must be pointed out that the observations of the Supreme Court in Metal Box Company of India Ltd.,'s case : (1969)ILLJ785SC though made in the context of a case involving payment of bonus to industrial workers were based on standard text books on accountancy, as pointed out by Shelat J., like Spicer and Pegler's Book-keeping and Accounts, 15th dition, page 42, William Pickles' Accountancy, second edition, page 192, and Part III, clause 7, Schedule VI, to the Companies Act, 1956, which defines 'provision' and 'reserve'.

36. Coming to the distinction between 'reserves' and 'provisions', particularly in the context of company law, we may point out that according to Gower's book, The Principles of Modern Company Law, third edition, page 463 :

'The aggregate amount of reserves and provisions are to be stated under separate headings. These are defined, and the essential distinction between them is that a provision is an amount set aside to meet a known liability the exact amount of which cannot be determined with accuracy, whereas a reserve is an amount retained to meet unknown eventualities' and it must be pointed out that the same principle was accepted by the Supreme Court in the Metal Box Company of India Ltd.,'s case : (1969)ILLJ785SC .

Under the Companies Act, 1956, sections 209 and 210 deal with the books of account to be kept by the company and annual accounts and balance-sheet. Section 211 provides for form and contents of balance-sheet and Profit and loss account. Sub-section (1) of section 211 provides :

'Every balance-sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year and shall, subject to the provisions of this section, be in the form set out in Part I of Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central Government either generally or in any particular case; and in preparing the balance-sheet due regard shall be had, as far as may be, to the general instructions for preparation of balance-sheet under the heading 'Notes' at the end of that part.'

37. When one turns of Schedule VI of the Companies Act, one finds in Part I the form of balance-sheet. In the balance-sheet 'Current liabilities and provisions' are separately mentioned. Item No. (4) under the heading 'Current liabilities and provisions' is 'Advance payments and unexpired discounts for the portion for which value has still to be given' and item No. (8) under the head 'Current liabilities and provisions' is 'Provision for taxation' and item No. (9) is 'Proposed dividends'. The learned Advocate-General appearing on behalf of the revenue has laid considerable stress on this form of the balance-sheet which is statutorily prescribed. Part III of the Schedule VI deals with 'Interpretation' and under rule 7 set out in Part III, clause (a) :

'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.'

whereas under clause (b) of sub-rule (1) of rule 7, the expression 'reserve' shall not, subject as aforesaid, include any amount written 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-rule (2) of rule 7 provides in Part III of Schedule VI that :

'(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 known 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.'

38. William Pickles Textbook on Accountancy, third edition, at page 184, makes this distinction between 'reserves' and 'provisions'. 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, whereas 'provisions' are amounts set aside out of profits and other surpluses to provide for (a) depreciation, renewals or diminution in value of assets, or (b) any known liability of which the amount cannot be determined with substantial accuracy. According to Pickles :

'It follows, therefore, that -

(i) 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, and

(ii) 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.'

It has been stated in Pickles at page 185 :

'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 proprietorship in the form of a liability or diminution of an asset. The former are broadly appropriations of, the latter charges against, profits.'

Thus it clearly emerges that reserves are appropriations out of the profits whereas provisions are charges against profits. At page 188, Pickles has pointed out that :

'Where there is a possibility that upon the happening of a contingency an actual liability will arise, it is not usual to make any relevant provision in the accounts, but by way of a footnote to the balance-sheet.'

'If the contingency does arise it will involve a loss. The liability incurred may be reflected in an asset, e.g., the call on the share may arise because the company is in difficulties, in which case the liability incurred will probably be considered a loss.'

As is very clear from the decisions of the Schedule particularly in Standard Vacuum Oil company's case : [1966]59ITR685(SC) and First National City Bank's case : [1961]42ITR17(SC) , the standard textbooks on accountancy have also to be taken into account.

39. When the matter was being argued before us it was stated at the Bar by Mr. Kaji appearing on behalf of the assessee that the provision of Rs. 3,26,0000 in the accounts for calendar year 1961, which was by way of 'taxation provision' was for the tax liability on profits earned in 1961 and it was urged by the learned Advocate-General on behalf of the revenue that in view of this statement made at the Bar, the provision for tax liability was a provision as understood in the Companies Act and not a reserve. It was further contended by the learned Advocate-General that so far as the dividend account was concerned, the amount of Rs. 2,13,600 was not a reserve and the matter was governed by Century Spinning and .,'s case : [1953]24ITR499(SC) .

40. It is clear that, so far as provision for taxation reserve, namely, Rs. 3,31,069 is concerned, the amount was set apart for meeting liabilities known to exist and it was a provision as distinguished from a reserve. Different considerations will, however, apply so far as the amount of Rs. 2,13,600 is concerned. This amount was standing in the 'proposed dividend' account of December 31, 1961. In view of the decision of the Supreme Court in Mysore Electrical Industries Ltd.,'s case : [1971]80ITR566(SC) it, is obvious that though the resolutions of the board of directors of the company in general meeting were passed subsequently, those resolutions relate back to December 31, 1961. The decision of the Bombay High Court in Aryodaya Ginning and .,'s case : [1957]31ITR145(Bom) clearly shows that when directors make certain appropriation of the profits for the year under consideration and the profits brought forward from the previous year and allocate certain amounts to the dividend reserve fund the amount in the dividend reserve fund must be taken into account in computing the capital for the purpose of rule 1 of Schedule II to the Act of 1947. It is clear that the question that we have to ask ourselves is, whether at the end of the calendar year, that is, as on December 31, 1961, the amount of Rs. 2,13,600 was set apart for a specific purpose to be put to use in future. That is the ratio of the Schedule decision in Century which has been applied in subsequent cases. As Shah J. pointed out in Standard Vacuum Oil Company's case : [1966]59ITR685(SC) , in its ordinary meaning, the expression 'reserve' meant something specifically kept apart for future use or for a specific occasion. The accounting practice followed by the company has to be taken into account and the requirement of statute which the assessee-company is required to follow have also to be borne in mind. It is because of this account-keeping practice that the statute imposes upon the assessee-company under the Indian Companies Act, 1956, particularly the form of the balance sheet, that this distinction between 'provision' and 'reserve' also becomes material for the purpose of finding out what exactly constitutes 'reserve' under rule 1 of Schedule II to the Act of 1963. It is true that though that Indian Companies Act was in force when the Act of 1963 was enacted, there is no reference in the definition section to the Companies Act, 1956, but in view of the decision of the Supreme Court in Standard Vacuum Oil Company's case : [1966]59ITR685(SC) , it is really not necessary that there should have been any such reference in the definition section because the requirement of the statute which the company is required to follow in its account-keeping practice have to be taken into consideration while considering this question of reserve.

41. In the Guide to Company Audit, third edition, 1972, published by the Research Committee of the Institute of Chartered Accountants of India, at page 70, the treatment in accounts of liability for taxation and proposed dividend has been discussed and the Committee has opined as follows :

'(a) The Committee was in agreement with the view that provision for the anticipated tax on the profits of the year should be made in the accounts irrespective of the fact that the Finance Act for the succeeding assessment year may not have been enacted. This view is based on the premise that taxes on income are something which, but for a possible variation in the rates, are with us for all time to come, and the mere fact that the Finance Act has not been enacted, should not except for the determination of the rates standing in the way of a company making a provision for the anticipated tax.

(b) With regard to the matter of the non-provision of the proposed dividend, the correct position in the view of the Research Committee, is that the proposed dividend does not represent a liability nor does it amount to a provision, pending the approval of the shareholders general meeting. Since the meeting to approve the accounts would take place after the balance-sheet date, there could not be any liability in respect of the proposed dividend on the date of the balance sheet. The Committee feels that merely because the form requires proposed dividend to be shown under 'Current Liabilities and Provisions' it does not mean that in fact the proposal for the dividend becomes a liability or is necessarily a provision. The committee would draw attention to the forms of accounts laid down under the Insurance Act, 1938, and the Banking Regulation Act, 1949, in both of which it is not a requirement to show 'proposed dividends' by either insurance companies or banking companies, and it cannot be contended that merely because 'proposed dividend' is not shown in the accounts, that the accounts of insurance and banking companies do not disclose a 'true and fair' view.

(c) Since, however, the form of balance-sheet prescribed in Part I of Schedule VI requires 'proposed dividends' to be shown under 'provisions', and since paragraph 3(xiv) of Part II of the same Schedule requires the 'proposed dividends' to be disclosed, the Committee feels that, though on correct accounting principles, the proposed dividend does not become a liability for reasons mentioned above, the attention of the shareholers would have to be drawn to the fact that no appropriation has been made for the proposed dividend the amount in respect of which should be specified.'

It is true, as Mr. Kaji has contended, in the light of the decisions of the Supreme Court discussed above, that it is the substance and not the form that matters and if there is no existing liability as at the date of the balance-sheet, that is, December 31, 1961, in the instant case, the amount set apart for the dividend cannot be said to be an amount set apart for meeting a present liability. Though, therefore, under the Companies Act, the proposed dividend has to be shown under the heading 'provision', in substance, it amounts to a 'reserve' as known to accountancy practice which has been approved by the Supreme Court in the Metal Box Company of India Ltd.,'s case [1969] 73 ITR . Under these circumstances we must hold that the amount of Rs. 2,13,600 standing in the proposed dividend accounts as on December 31, 1961, was includible in computing the capital of the company but the amount of Rs. 3,31,069 standing in the 'provision for taxation account' as on December 31, 1961, was not includible in computing the capital of the company.

42. Under these circumstances, we answer question No. 1 in the negative, that is, in favour of the revenue and against the assessee. We answer question No. 2 in the affirmative, that is, in favour of the assessee and against the revenue. In view of the fact that each side has partly succeeded and partly failed, there will be no order as to costs of this reference.


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