1. The assessee is a public limited company engaged at the relevant years in the manufacture and sale of yarn. It installed machinery, the cost of which amounted to Rs. 10,59,634 for the year ended March 31, 1958, to Rs. 5,82,142 for the next year and to Rs. 3,12,470 for the third year. But production commenced from January 1, 1958. For the year ended March 31, 1958, there was no assessment. In the previous year ended March 3,1', 1959, the assessee made a profit of Rs. 89,034 according to its books out of which it distributed as dividend Rs. 60,726 and set apart Rs. 7,719 as development rebate reserve. After adjusting the balance of Rs. 20,589 against the loss of the earlier year, the assessee filed a return showing a loss of Rs. 64,247. The assessment was completed by fixing the loss at Rs. 60,693. In the next year, the assessee made a profit of Rs. 1,83,372. Out of this sum was distributed as dividend a sum of Rs. 78,582 ; a sum of Rs. 67,621 was set apart as development rebate reserve though, having regard to the installation cost, a sum of Rs. 58,227 would have sufficed. Out of the balance, a sum of Rs. 35,000 was transferred to the general reserve and the remaining sum of Rs. 2,169 was carried over to the next year. TheIncome-tax Officer disallowed development rebate in respect of the first two years, Rs. 2,64,908 and Rs. 1,26,061, respectively, but allowed it in full for the assessment year 1960-61 in the sum of Rs. 77,703. The ground for disallowance was that there was no assessment for the first year and there was no claim made for the assessment year 1959-60. The Appellate Assistant Commissioner of Income-tax declined to interfere. He pointed out that the assessee had also failed to furnish the particulars necessary to compute the rebate for the assessment year 1959-60. The Tribunal sustained the disallowance for the year ended March 31, 1958, on a new plea raised by the revenue which it allowed, to wit, the provision for carrying forward of development rebate was itself introduced only with effect from April 1, 1958, by the Finance Act of 1958. As to the second year, the Tribunal, disagreeing with the revenue, found that the assessee had, as a matter of fact, furnished on December 30, 1960, the necessary particulars and that as it happened to be before the assessment was completed, it was sufficient compliance. The Tribunal further held that, since the assessee had created a reserve of Rs. 7,719 in the previous year, it would be entitled to development rebate of Rs. 10,292 to be brought forward and adjusted against the profits of the assessment year 1960-61. But, as no corresponding reserve had been created for the balance of the claim for rebate for the assessment year 1959-60, the Tribunal sustained the order of the Appellate Assistant Commissioner to the extent of Rs. 1,18,342 disallowed for carrying over. In the circumstances, this reference under Section 256(1) of the Income-tax Act, 1961, comes before us on the question :
'Whether, on the facts and in the circumstances of the case, the assessee-company is entitled to have the unadjusted development rebate of Rs. 2,64,908 in respect of new machineries installed in the account year ended March 31, 1958, and Rs. 1,18,342 in respect of new machineries installed in the account year ended March 31, 1959, set off against the profits of the year ended March 31, 1960, and carry forward the whole or part of the unadjusted rebate to the later years '
2. Regarding the first year ended March .31, 1958, the decision of the Tribunal is correct. This is because the provision enabling carry forward of development rebate introduced by the Finance Act of 1958 itself came into force but with effect from April 1, 1958, and the machinery had been admittedly installed prior to January 1, 1958. No question of carrying forward of any development rebate in respect thereof could, therefore, arise.
3. Before we proceed further, let us notice the relevant statutory provisions. Section 10(1) directs that tax shall be payable by an assessee in respect of the profits or gains of any business carried on by him. Subsection (2) provides for computation of such profits or gains after making the appropriate allowances. Under Clause (vib), if machinery was installedafter March 31, 1954, but before April 1, 1961, and was wholly used for the purpose of the business carried on by the assessee, twenty-five per cent. of its actual cost is allowable as development rebate in respect of the year of installation. The clause has two Explanations and also two provisos. The first Explanation provides that so much only of such development rebate be allowed as will go to reduce the total income of such year to nil and the balance of the development rebate not allowed shall be carried forward to the following year but subject to the condition that no portion of the development rebate shall be carried forward for more than eight years. The allowance of rebate is thus always in respect of the year of installation and, apart from the creation of requisite reserve, depends on and goes to reduce the available total income of that year or the following previous year. If there is no such total income or it is a loss, there can of course be no allowance of rebate but it is to be carried forward to the following years. We think that total income in this regard means the income aggregated from all heads and before deduction of development rebate and as assessed. Explanation 2 provides that the development rebate carried forward shall first be set off every time against the successive current year's total income of the assesses. Then comes the following first proviso :
' Provided that no allowance under this clause shall be made unless-
(a) the particulars prescribed for the purpose of clause (vi) have been furnished by the assessee iu respect of the ship or machinery or plant; and
(b) except where the assessee is a company being a licensee within the meaning of the Electricity (Supply) Act, 1948 (LIV of 1948), or where the ship has been acquired or the machinery or plant has been installed before the 1st day of January, 1958, an amount equal to seventh-five per cent, of the development rebate to be actually allowed is debited to the (profit and loss account of the relevant previous year and credited to a reserve account to be utilised by him during a period of ten years next following for the purposes of the business of the undertaking, except-
(i) for distribution by way of dividends or profits ; or
(ii) for remittance outside India as profits or for the creation of any asset outside India,
and if any such ship, machinery or plant is sold or otherwise transferred by the assessee to any person other than the Government or for any consideration not connected with any amalgamation or succession referred to in Clause (vic) at any time before the expiry of ten years from the end of the year in which it was acquired or installed, any allowance made under this clause shall be deemed to have been wrongly allowed for the purposes of this Act.'
4. Unless the two conditions in the first part of the proviso are satisfied, no development rebate can actually be allowed. As to the first conditionwhen the particulars should be furnished does not appear but we are of opinion that they should be furnished at least before the assessment is completed for the year in respect of which the claim for the allowance is ade. The second condition is that an amount equal to 75 per cent. of the development rebate to be allowed is debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during a period of ten years next following for the purposes of the business of the undertaking. In our view, it will not be sufficient compliance with the condition if no reserve is actually created to the extent required. Mere book entries without actual reserve will not suffice. The entries as required by the condition are of course a sine qua non and are not an idle formality, for it is only then that it will be possible to keep track of the Development rebate reserve for the purpose of enforcing the particular inh. itions against its user. The permitted user and the inhibitions point to the entry in the profit and loss account and the reserve account being of the actual reserve created. The clause itself contemplates that such a reserve is capable of being utilised and may be expected to be utilised for the purpose of the business and further, as contemplated by the exception, it is prohibited from being distributed as dividends or profits or remitted outside India as profits or for the creation of any asset outside India. There is also an additional reason that if within ten years of the installation of the machinery it is sold, Clause (b) directs that any allowance made under it shall be deemed to have been wrongly allowed with the consequence that the assessee will have to make good the deficiency to the revenue. Because of these considerations, we think the requisite under Clause (b) of the proviso is the creation of an actual reserve to the extent required, not merely book entries, debiting to the profit and loss account and crediting to the reserve account. It is true that the clause speaks of an amount equal to 75 per cent. of the development rebate to be actually allowed. It is asked how the amount equal to the statutory percentage could be ascertained until the development rebate is actually allowed. But we think that the assessee being in possession of all the facts as to the cost of the machinery and claim for rebate, he should fairly be in a position to know or foresee how much would probably be allowed as development rebate so that the 75 per cent. thereof could be set apart as reserve. But previous creation of the reserve is not a condition to making a claim for rebate unlike to actual allowance of it. Before completion of assessment, therefore, and as and when the development rebate to be actually allowed against the requisite reserve to be made in the light of the particulars furnished and claim made is ascertained by the Income-tax Officer, he will have to give a reasonable opportunity and time to the assessee to set apart an amount equal to 75 per cent. of theamount proposed to be allowed and then debit the same to the profit and loss account and credit to the reserve account,
5. In our opinion, the scheme of Clause (vib) therefore comes to this. For each year nf installation of machinery, the assessee will in or along with his return make a claim for development rebate with the necessary and relevant particulars furnished at least before completion of the assessment. The actual allowance of the claim will depend upon compliance with the requisites of Clauses (a) and (b) of the proviso as already explained by us. If in the assessment year relevant to the year of installation, the total assessed income of the assessee from all heads is nil, the assessee cannot naturally be expected to have created an actual reserve equivalent to 75 per cent. of the development rebate to be allowed. He is not penalised for his inability but, in such an event, the development rebate to be allowed will have to be, provided he has furnished the necessary particulars before completion of assessment, computed by the revenue and carried forward to the following year so that it may first, as a priority item, be to the extent possible and warranted by the actual reserve set apart in that year, set off against his total assessed income of such year. It should be noted that such allowance in each year, as indicated by us, can only be made with reference to and to the extent warranted by the actual reserve created and the balance of the rebate to the extent not covered by reserve because the assessed total income is nil or inadequate, should be carried forward to the next year. The carrying forward of development rebate is however not permitted only by mere book entries debiting it to the profit and loss account and crediting it to a reserve account of the relevant previous year. Such an entry can be expected to be made and should be made only when there is income available to the assessee as per the assessment results out of which the reserve could to any extent be made.
6. If in a particular assessment year, there is income available according to the assessment but the whole or a portion of it has been distributed as dividends or as profits and for that reason the assessee has failed to create a reserve as required by Clause (b) of the proviso, we are inclined to think that the consequence would be that to the extent of such failure, the assessee will be disentitled to carry forward the development rebate. This is because, as we consider, carry forward is allowed only if the failure to create a reserve on the part of the assessee is on account of the fact that there is no income available in the assessee's hands in the relevant year out of which the requisite reserve or any part of it could actually be created. If the assessee who could have created a reserve to any extent out of the total income as determined by the assessment in a given year, did not create it but distributed such income as dividends or profits, he is only to blame and the benefit of carrying forward would not be available to a defaultingassessee to the extent of such failure. When a reserve is actually created with reference to which alone development rebate is allowed, there is prohibition against any part of such reserve being distributed as dividends. We think that this provides the reason for denying the development rebate if failure to create a reserve is on account of the fact that the funds which can be utilised for the purpose have been distributed for purposes forbidden by Clause (b) of the proviso and not on account of the inability of the assessee to create a reserve for want of assessed income in its hands.
7. In our opinion, the scheme of Clause (vib) as thus envisaged by us would admit of its practical working. It is contended for the revenue that all that is contemplated by Clause (b) of the proviso is to debit the profit and loss account of the relevant previous year and credit to a reserve account an amount equal to 75 per cent of the development rebate to be actually allowed and for this purpose it is not required that an amount equal to that percentage should be actually set apart as reserve. Having regard to our understanding of the entire provision of Clause (b) of the proviso, we are unable to accept this contention. We cannot overlook the word 'utilised' in Clause (b) of the proviso and the expectation that the reserve contemplated by this provision could be utilised for the purpose of the business but not for the prohibited purposes. That shows clearly that debiting in the profit and loss account and crediting in the reserve account is not theoretical but on the basis of actual reserve created. One other question that may arse is whether the requirement to credit a reserve account as a condition for carrying forward arises when there are book profits but the total income as per completed assessment is nil or the assessment-result is a loss in any given year. In our view, the basis should be the total profits as per completed assessment and not book profits. This is because Explanation I shows that the develcpment rebate to be allowed for any assessment year should only be such amount as would be sufficient to reduce the total income of that year to nil. That cannot refer to book profits. It follows, therefore, in our opinion, that although the books may show profits, if the assessment results in nil income or loss, there will then be no obligation on the part of the assessee to create a reserve as a condition for carrying over the devjlop-ment rebate.
8. On applying the principles we have set out above to the instant reference, the result will be as follows : The assessment for the assessment year 1959-60 showed a loss. No question of debiting to the profit and loss account and crediting to the reserve account therefore arises. The assessee would, therefore, be entitled to carry forward the entire development rebate for that year to the following year, namely, the sum of Rs. 1,26,061. But since, notwithstanding the loss as per the assessment, the assessee had in that year created a reserve of Rs. 7,719, it would be entitled to an allowanceof development rebate to the extent of Rs. 10.292 to be set off first against the total assessed income of the following assessment year 1960-61. Similarly, the balance of the development rebate carried forward from the assessment year 1959-60 would, to the extent warranted by the reserve created in the assessment year 1960-61, be then eligible to set off as against the balance of the total assessed income of that year. Then if after adjusting against the total income still available the current development rebate to be allowed for the assessment year 1960-61 in respect of the balance, if any, of the reserve created in that year, there is still any unabsorbed balance of development rebate, it is entitled to be carried forward.
9. We now answer the reference as follows, partly in favour of the assessec and partly against it. The disallowance of development rebate for the assessment year 1958-59 is correct. The entire development rebate for the next year should be carried forward to the following year which will to the extent warranted by the sum of Rs. 7,719 set apart as reserve in the assessment year 1959-60 and the reserve of Rs. 67,621 created in the assessment year 1960-61, be first set off against the total assessed income for the assessment year 1960-61. The current development rebate for the assessment year 1960-61 will then, to the extent covered by the balance, if any, of the reserve for the assessment year 1960-61, be allowed and set off against the balance, if any, of the assessed income of that year. The unabsorbed balance of the development rebate will be carried forward to the following year. It is hardly necessary to say that our answer accordingly requires recomputation and revision of the assessments for the assessment years 1959-60 and 1960-61. We make no orders as to costs.