Rajagopala Ayyangar, J.
1. This reference under Section 66 (2) of the Indian Income-tax Act raises for consideration the proper construction of Rules 2 (b) and 3 (a) of Schedule I to the Indian Income-tax Act. The assessee is the Indo Union Assurance Co. Ltd., Madras, which carries on the sole business of life insurance; and in regard to its assessment for the assessment year 1947-48, the following question arose which has been referred to this Court for decision :
'Whether on the facts and in the circumstances of the case, one half of the amount of Rs. 58652 should not have been allowed as a deduction under Rule 3 (a) of the Schedule to the Income-tax Act in computing the surplus for the purpose of Rule 2 (b) of the said schedule?'
The previous or accounting year in question is the Calendar year 1946. The last actuarial valuation of the company was made for the inter-valuation period commencing from 1-1-1942 and ending on 31st December, 1945. This disclosed a deficit of Rupees 1642. The immediately preceding actuarial valuation which was made for the period from 1-4-1937 to 31-12-1941 disclosed an actuarial deficit of Rs. 49745. The difference between the two, namely, the inter-valuation profit for the four years from 1942 to 1945 was Rs. 48103.
2. The profits of an insurance business are, under Section 10 (7) of the Income-tax Act, to be computed in accordance with the rules set out in the schedule to the Act. Rules 1 to 5 are relevant to an assesses carrying on the business of life insurance, and Rules 2 and 3 determine the basis upon which the profits or gains should be computed. The portions of the rules material to the present case are:
(2) The profits and gain's of life insurance business shall be taken to be either: (a) The gross external incomings of the preceding year from that business less the management expenses of that year; or (b) the annual average of the surplus arrived at by adjusting the surplus or deficit disclosed by the actuarial valuation made for the last inter-valuation period ending before the year for which the assessment is to be made so as to exclude from it any surplus or deficit included therein which was made in any earlier inter-valuation period and any expenditure other than expenditure which may under the provisions of Section 10 of this Act be allowed for in computing the profits and gains of a business........
(3) In computing the surplus for the purpose of Rule 2 (a) one half of the amounts paid to or reserved for or expended on behalf of policy-holders shall be allowed as a deduction. Provided that in the first such computation made under this rule of any such surplus no account shall be taken of any such amounts to the extent to which they are paid out of or in respect of any surplus brought forward from a previous inter-valuation period: Provided further that if any amount so reserved for policy-holders ceases to be so reserved, and is not paid to or expended on behalf of policy-holders one-half of such amount, if it has been previously allowed as a deduction, shall be treated as part of the surplus for the period in which the said amount ceased to be so reserved:
3. In respect of the assessment now in question, the assessed filed a return, showing a profit of Rs. 9091 computed under Rule 2 (a) of Schedule I. The correctness of this figure is not in dispute. But as the higher of the two figures of the profit computed in accordance with Rules 2 (a) and 2 (b) is to be the basis of taxation, the company also gave figures of its computation under Rule 2 (b). After adding back some deductions which were not permissible and certain refunds, the total actuarial inter-valuation profit within Rule 2 (b) was arrived at as Rs. 58652. The Income-tax Officer added a further sum of Rs. 1600 to the profit to be calculated under Rule 2 (b) representing an item of bad debt disallowed, and as regads this addition there is no dispute. The total was computed at Rs. 60252. If this figure were taken as the profit disclosed during the inter-valuation period, this would have to be divided by four, and the surplus for each year would be Rs. 15063, and as the figure under Rule 2 (b) is the higher, this would form the basis of taxation.
4. The assessee, however, raised a contention, that there should be a deduction of one-half of the amount of the total inter-valuation profit under Rule 3 (a) on the ground, that on the proper construction of the provisions of the Indian Insurance Act, this en-tire inter-valuation profit was 'reserved for the benefit of policy-holders'. It is the correctness of thisargument that is raised by the question now underreference.
5. There is no dispute as regards the figure arrived at on the basis of Rule 2 (a). It is therefore unnecessary to say anything more about it, nor is there any dispute as to the result of the computation under Rule 2(b). Rule 2(b), in its present form, dates from 1941, but it is unnecessary to spend any time over detailing the changes effected by the Amending Act of 1941, since it is common ground that this rule is directed to ascertain the true inter-valuation profit, that is, the difference between the profits as disclosed by two actuarial valuation separated each other by a number of years. The language of this rule is far from clear, and there is such a repetitive periphrasis as to shroud in obscurity the exact meaning which the framers had in view. As we have already stated, in this reference we are not concerned with the ascertainment of the inter-valuation profit to be taken as the profit of the company for the purpose of taxation.
6. The only question is, is this inter-valuation profit or any part of it 'reserved for the benefit of policy-holders' so as to permit the deduction of one half of this amount in computing the surplus for the purpose of Rule 2, in the present case, Rule 2 (b). Rule 3 (a) refers to amounts paid to, or reserved for, or expended on behalf of policy-holders. The argument of the learned Advocate General, who appeared on behalf of the assessee, was not that any of the inter-valuation profit was 'paid to' or 'expended on behalf of policy-holders', but only that it was 'reserved' on behalf of them, and that the provisions of, the Insurance Act, constituted a statutory reservation of these amounts on behalf of policy-holders so as to satisfy the terms of Rule 3 (a).
7. We shall now set out in broad outline the argument on behalf of the assessee, Rule 3 (a) does not require the reservation for the benefit of the policy-holders to be by a particular authority or that it should be in any particular manner. The rule would be satisfied if under the law any amounts were reserved for the benefit of the policy-holders, and the company is unable to use it for any other purpose. That reservation need not be by the actuary, or carried out in the balance-sheet, or by appropriation by the directors. But it is sufficient if the relevant statute, in this case the Insurance Act, 1938, of its own force effects this reservation. So far, this argument is sound, and the learned counsel for the commissioner did not contend that if the statute reserved any part of the surplus to the policy-holders, it would not be a reservation within Rule 3 (a). The question, however, is whether the Insurance Act has done so.
8. The provisions of the Insurance Act were analysed by the learned Advocate General, and he placed particular reliance on Section 49 as effecting this statutory reservation. We shall be setting out the section in an instant. But before doing so, it would be convenient to refer to the other provisions which were referred to in this connection. Section 10 (2) makes provision for the manner in which an insurer who carries on the business of life insurance should keep the receipts in respect of that business. Section 10 (2) runs thus :
'Where the insurer carries on the business of life insurance all receipts due in respect of such business shall be carried to and shall form a separate fund to be called the life insurance fund the assets of which shall after the expiry of six months from the commencement of the Insurance (Amendment) Act, 1946, be kept distinct and separate from all other assets of the insurer and the deposit made by the insurer in respect of life insurance business shall be deemed to be (part of the assets of such fund) and every insurer shall, within the time limited in Sub-section (1) of Section 15 in regard to the furnishing of the statements and accounts referred to in Section 11, furnish to the Controller a statement showing in detail such assets as at the close of every calendar year duly certified by an auditor or by a person qualified to audit under the law of the insurer's country.
Provided that such statement shall, in the case of an insurer to whom Section 11 applies, be set out as a part of the balance-sheet mentioned in Clause (a) of Sub-section (1) of that section.
Provided further that an insurer may show in such statement all the assets held in his life department, but at the same time showing any deductions on account of general reserve and other liabilities of that department.
Provided also that the Controller may call for a statement similarly certified of such assets as at any other date specified by him to be furnished within a period of three months from the date with reference to which the statement is called for.
In the case of composite companies carrying on life insurance along with other lines of insurance business, Section 10 (3) enacts :
'(3) The life insurance fund shall be as absolutely the security of the life policy-holders as though it belonged to an insurer carrying on no other business than life insurance business and shall not be liable for any contracts of the insurer for which it would not have been liable had the business of the insurer been only that of life insurance and shall not be applied directly or indirectly for any purposes (other than those) of the life insurance business of the insurer.' Section 13 contains the provision for the actuarial valuation and report. The operative part of this provision is to be found in Sub-section (1) which runs thus :
'Every insurer carrying on life insurance business shall, in respect of the life insurance business transacted by him in India and also in the case of an insurer specified in Sub-clause (a) (ii) or Sub-clause (b) of Clause 9 of Section 2 in respect of all life insurance business transacted by him once at least in every three years cause an investigation to be made by an actuary into the financial condition of the life insurance business carried on by him, including a valuation of his liabilities in respect thereto and shall cause an abstract of the report of such actuary to be made in accordance with the regulations contained in part I of the Fourth Schedule and in conformity with the requirements of Part II of that schedule.' The rest of the provisions deals with matters not very relevant in the present context. The fourth schedule which is referred to in Section 13 (1) comprisestwo parts. The first part contains regulations forthe preparation of abstracts of Actuaries' reports andrequirements applicable to such abstracts Part II,which is really material in the present context setsout the requirements applicable to an abstract in respect of life insurance companies. The opening paragraph of this part contains the following requirements :
'The following tabular statements shall be annexed to every abstract prepared in accordance with the requirements of this part of this schedule namely :
(a) a consolidated revenue account, in the form G annexed to this part of this schedule for the inter-valuation period (except that it shall not be necessary to prepare such an account in respect of any class of business so long as the insurer deposits annually with the controller an abstract in respect of that class of business; and
(b) a summary and valuation in the form H annexed to this Part of this schedule of the policies included at the valuation date in the class of business to which the abstract relates; and
(c) a valuation balance sheet in the form I annexed to this Part of this schedule, and . . .
(d) . . . . .
and every such abstract shall show:
6. The basis adopted in the distribution of profits as between the insurer and policy-holders and whether such basis was determined by the instruments constituting the company, or by its regulations or bye-laws, or how otherwise; .....
8. (1) The total amount of profits arising during the inter-valuation period, including profits paid away and sums transferred to reserve funds or other accounts during that period, and the amount brought forward from the preceding valuation (to be stated separately) and the allocation of such profits,
(a) to interim bonus paid;
(b) among policy-holders with immediate participation giving the number of the policies which participated and the suras assured thereunder (excluding bonuses);
(c) among policy-holders with deferred participation giving the number of the policies which participated and the sums assured thereunder (excluding bonuses);
(d) among policy-holders in the discountedbonus class giving the number of the policies whichparticipated and the sums assured thereunder (excluding bonuses);
(e) to the insurer or, in the case of an insurancecompany, among share-holders or to share-holders'accounts (any such sums passed through the accounts during inter-valuation period to be separatelystated);
(f) to every reserve fund or other fund or account (any such sums passed through the accounts during the inter-valuation period to be separatelystated);
(g) as carried forward unappropriated.' The consolidated revenue account which is to confirm to the requirements of form (G) might be referred to before dealing with the terms of Section 49. Form G is in these terms:
FORM CConsolidated Revenue account of for years commencing and ending
Business within India.Total.Business within India.Total.
Claims under policies (including provision for claims due or intimated less re-insurances:
Annuities less re -insurances surrenders (in cluding surrenders of bonus) less Re-insur ances.
Bonuses in cash, less re-insurance.
Bonuses in reduction of premiums less reinsurances.
Expenses of management (b), (e).
1 (a) Commission to insurance agents (less that on re- insurances.)
(b) Allowances and commission (other than commission included in sub-item (a) preceding.)
2. Salaries, etc., (other than to agents and those contained in sub-item (in) (b) pre ceding).
3. Travelling expense.
4. Directors' fees.
5. Auditors' fees.
6. Medical fees.
7. Law charges.
9. Printing and stationary.
10. Other expenses of management (accounts to be specified).
11. Other payments (accounts to be specified).
12. Rent for offices belonging to and occupied by the insurer.
13. Rents of other offices occupied by theinsurer.
United Kingdom, (Indian), Dominion and Foreign taxes.
Other expenditure (to be specified). Profit transferred to profit and loss account. Balance of life insurance fund at end of the period as shown in the balance-sheet.
Rs.Balance of life Insurance fund at the beginning of the period
Premiums less re-insurances,
(i) First year premiums.
(ii) Renewal premium.
(iii) Single premiums consideration for annui ties granted less re-insurances (c)_In-terest. dividends and rents Rs. Less- Income-tax thereon (b) Rs.
Other income (to be specified).
Loss transferred to profit and loss account. Transferred from appropriation account.Rs.
Form (I) is the form of the valuation balance-sheet from which inter-valuation profits are ascertainedand runs thus :FORM IValuation balance-sheet of as at 19
Net liability under business as shown in the summary and valuation ot' policies.Rs.Balance of life insurance fund as shown in the balance-sheet.Rs.Surplus, if any. Deficiency, if any.
9. Now, we might refer to Section 49, on which almost the entire case of the assesses is rested:
'49(1) : No insurer, being an insurer specified in Sub-clause (a) (ii) or Sub-clause (b) of Clause (q) of Section 2 who carries on the business of life insurance or any other, class pr sub-class of insurance business to which Section 13 applies shall for the purpose of declaring or paying any dividend to share-holders or any bonus to policy-holders or of making any payment in service of any debentures, utilise directly or indirectly any portion of the life insurance fund or of the fund of such other class or sub-class of insurance business, as the case may be, except a surplus shown 'in the valuation balance sheet in form I as set forth in the fourth schedule submitted to the Controller as part of the abstract referred to in Section 15 as a result of an actuarial valuation of the assets and liabilitiesof the insurer; nor shall he increase such surplus by contribution out of any reserve fund or otherwise unless such contributions have been brought in as revenue through the revenue account applicable to that class or sub-class of insurance business on or before the date of the valuation aforesaid except when the reserve fund is made up solely of transfers from similar surpluses disclosed by valuations in respect of which returns have been submitted to the Controller under Section 15 of this Act or to the Central Government under Section 11 of the Indian Life Assurance Companies Act, 1912.
Provided that payments made out of any surplus in service of any debentures shall not exceed fifty per cent, of such surplus including any payment by way of interest on the debentures and interest paid on the debentures shall not exceed ten per cent, onany such surplus except when the interest paid on the debentures is off-set against the interest credited to the fund or funds concerned in deciding the interest basis adopted in the valuation disclosing the aforesaid surplus.
Provided further that the share of any such surplus allocated to or reserved for the share-holders (including any amount for the payment of dividends guaranteed to them, whether by way of first charge or otherwise) shall not exceed seven and a half per cent of such surplus.'
The prohibition enacted by this section is enforced by Section 106 under which the directors of an insurance company who diminish the amount of the life fund by distribution contrary to the terms of the enactment are subjected to punishment. Section 106 (1) run thus :
'106 (1): If on the application of the Controller or an Insurer or any member of an insurance company or any policy holder or the liquidator of an insurance company in the event of the insurer being in liquidation the Court is satisfied that by reason of any contravention of the provisions of this Act the amount of the life insurance fund has been diminished every person who was at the time of the contravention of a director, manager, liquidator or an officer of the insurer shall be deemed in respect of the contravention to have been guilty of misfeasance in relation to the insurer unless he proves that the contravention occurred without his consent or connivance and was not facilitated by any neglect or omission on his part; and the Court shall have all the powers which a Court has under Sections 235 and 237 of the Indian Companies Act, 1913, and shall also have the power to assess the sum by which the amount of the life insurance fund has been diminished by reason of the misfeasance and to order any person guilty thereof to contribute to that fund the whole or any part of that sum by way of compensation.' The steps in the argument of the learned Advocate General were shortly these: An inter-valuation profit even though it might be merely a difference between two deficiencies is still a real profit. That is the basis upon which Rule 2 (b) of the schedule in the Income-tax Act proceeds, and this is in accordance with commercial practice. The position in England, under the provisions of the English Finance Act in conjunction with the Life Assurance Act, was said to be that the inter-valuation profit in regard to a company still in deficit was treated as a real profit divisible among the share-holders and liable to be brought to tax as a true profit of the insurance company. It was urged that in India the position was altered by the terms of Section 49, by which inter-valuation profits were made not available to the share-holders until the life fund disclosed a surplus in the left hand column of form (I), annexed to fourth Schedule Part II of the Insurance Act, 1938. As the share-holders were prevented from utilising this type of inter-valuation profit, it was urged that it was 'reserved for the policy-holders' by the statute, and that this satisfied the terms of Rule 3 (a) of the schedule to the Income-tax Act.
10. We are unable to accept this argument of the learned Advocate General as to the effect of Section 49. The position in England so far as the taxation of the Assurance Companies are concerned appears to be shortly this :
Section 436 (1) of the U. K. Income-tax Act,1952 enacts :
'Where an assurance company carries on life assurance business in conjunction with assurance business of any other class, the former business is treated for income-tax purposes as a separate business.' As regards the taxation of the profits and gains of an insurer carrying on life assurance business the position is thus summed up in Simon:
'The Crown has an option to assess an assurance company either under Case I in respect of its profits or under Case III, IV or V of Schedule D upon its investment income. In other words, the Crown can assess the company's balance of profits or gains under case I of Schedule D, or alternatively it can assess the individual items of the company's investment income. This election of the Crown rests upon the principle that if a statute authorises taxation under alternative methods, the selection of the alternative lies with the taxing authority......
Where the profits of an assurance company in respect of its life assurance business are computed under Case I of Schedule D, that part of the profits which belongs to, or is allocated to, or is reserved for, or is expended on behalf of, policy-holders or annuitants has to be excluded in making the computation. But profits excluded because they are reserved for policy-holders or annuitants, which cease at any time to be so reserved, and are not allocated to, or expended on behalf of, policy-holders or annuitants, have to be treated as profits of the company for the year in which they ceased to be so reserved' (Income-tax Act, 1952), Section 427 (1) (Simon's Income-tax Second Edn. Vol. I at p. 427) ).
11. We are not able to appreciate the contention, that the provisions of the Indian Insurance Act effects a reservation of the entirety of the inter-valuation surplus for the benefit of policy-holders within Rule 3 (a) of the schedule to the Income-tax Act. To start with, we might mention, merely to put aside, the provision in Sections 10 (2) and (3) regarding separation of accounts and the uses to which the life-fund could be put. These provisions, which have been taken from the Life Assurance Companies Act of England, serve to segregate the funds pertaining to life assurance from other funds of composite companies but effect no allocation among the several purposes for which the funds of a life assurance company could be put. It is not the contention of the assessee that the corresponding provision in England has ever been held to constitute a reservation for policy-holders within Section 427 of the Income-tax Act, 1952 or the earlier provisions it re-enacted.
12. Does Section 49 of the Insurance Act, a similar provision to which is not in the U. K. Act, effect this reservation. We are clearly of the opinion that it does not. Reservation for the benefit of Policy-holders has to be a positive provision, whereas what Section 49 enacts is only a prohibition -- a prohibition against the use of the inter-valuation surplus of a particular kind for specified purposes. But for it, a dividend might be declared out of the sum, or it might be used to service debentures issued by the insurer. Further among the prohibited uses are the payment of bonuses out of the funds of an insurer whose life fund is still in deficit, and this in our judgment must inescapably lead to the rejection of the argument on behalf of the assessee.
13. Section 49 divides so to speak the profitsof an insurer into two categories -- an inter-valuation surplus and a surplus disclosed by a balance sheet in form (I), which latter emerges only when the life fund is in excess of the net actuarial liabilities and prohibits the distribution either to sharer holders or policy holders of an inter-valuation surplus where the company is stilt in deficit and permits distribution subject to exceptions not relevant here, only of the surplus disclosed in the left hand side in form (I) of the Valuation Balance-sheet.
14. Further a close examination of Form (G) in the fourth Schedule to the Insurance Act would show that there is no basis for the theory, that an inter-valuation surplus is reserved for policy-holders by statute. The balance of the life fund at the beginning of the period together with the further additional income which flows into it goes into making up the total on this side. The balance at the end of the year which is shown at the end of the left hand column of the account need not always or necessarily be in excess of the figure which forms the first item on the right hand side. During the year the company might have expended sums over and above the net receipts for the year by way of expenses of management which would include salaries to the staff, their travelling expenses as well as the remuneration to the directors etc., these being some of the 13 heads under which expenses of management are classified in that form. There might also be bad debts in the investment of the life fund which might be written off during the year. The net result of taking into account all these items might very well be that the life fund at the end of the year is less than the life fund at its beginning, If the argument of the learned Advocate General should be accepted, a life fund can never diminish because it is exclusively set apart for the policy-holders and the company cannot draw on it for any purpose except for payment of claims. But surely that is not the position; and as the company is able to deal with the life fund on the basis of which, of course, the inter-valuation surplus is calculated it is subject to diminution by expenditure on items other than payment of claims under policies. Therefore the life fund is at the disposal of the company for being used to meet its expenses, including the salaries of the Directors and their allowances, to mention only a few, which would clearly show that there is no reservation for policy-holders. The fact that, the life fund is not a fixed sum but a fluctuating one, though of course, in a majority Of cases having a tendency to increase, with still the possibility of there being a diminution of it reveals its true character. The inter-valuation profit is really an actuarial computation of the liabilities to which the life fund is subject at two dates separated from each other by a fixed number of years. In making these observations we are disregarding the fact that among the assets taken into account for making the actuarial calculation to the probability of the receipt of the renewal premiums as well as their investment is taken into account. In the present case, what is relevant is the fact, that a portion of the life fund, which might be said to represent that inter-valuation profit, can be utilised by the company for its purpose as seen from Form G the revenue account. In the light of these considerations, we are clearly of the opinion that what Rule 3 (a) contemplates isthe reservation that takes place as a result of the recommendation of the actuary under paragraph 8 ofPart II of Schedule IV to the Insurance Act. Whenonce such a reservation has been made it cannot bedrawn upon by the company for being used for anypurpose of its own including the expenses of management There is a segregation of that fund and itgets impressed with a trust in favour of the policy-holders. It is only then that it would be a reservation within Rule 3 (a) of the schedule. Moreoverthe second proviso to Rule 3 (a) would appear to indicate a reservation of this type and not one wherethere is merely a prohibition against uses falling within specified categories.
15. In our judgment, the construction adopted by the Tribunal is correct and the question is answered in the negative and against the assessee. The Commissioner of Income-tax is entitled to his costs, counsel's fee Rs. 250/-.