Govindan Nair, C.J.
1. With reference to the years of assessment 1965-66, 1966-67 and 1967-68, the following questions respectively have been referred to this court for its opinion:
Assessment Year 1965-66:
'Whether, on the facts and in the circumstances of the case, it has been rightly held that the sums of Rs. 91,510, Rs. 2,40,197, Rs. 19,03,252, Rs. 24,36,239 and Rs. 6,42,524 representing the premium deposits, unearned premium, provision for outstanding claims, provision for taxation and proposed dividends respectively did not all under Rule 2(i) of the Second Schedule to the Companies (Profits) Surtax Act, 1964?
Assessment Year 1966-67:
'Whether, on the facts and in the circumstances of the case, it hasbeen rightly held that the sums of Rs. 3,34,756, Rs. 1,70,463, Rs. 41,36,469,Rs. 17,21,932, Rs. 8,00,000 and Rs. 82,333 representing the premium deposits, unearned premium, provision for outstanding claims, provision fortaxation, proposed dividends and balance in the profit and loss account,respectively, did not fall under Rule 2(i) or Rule 2(ii) of the Second Scheduleto the Companies (Profits) Surtax Act, 1964 ?
Assessment Year 1967-68:
'Whether, on the facts and in the circumstances of the case, it has been rightly held that the sums of Rs. 93,250, Rs. 2,25,067, Rs. 25,17,281, Rs. 13,97,886, Rs. 7,48,110 and Rs. 7,071 representing the premium deposits, unearned premium, provision for outstanding claims, provision for taxation, proposed dividends and balance in the profit and loss account, respectively, did not fall under Rule 2(i) or Rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'
2. Before we proceed further, we would like to clarify the error in the years that have been mentioned. The facts as seen from the question purporting to be for the year 1966-67 actually relate to the year 1967-68 and those mentioned for the year 1967-68 are those applicable to the year 1966-67. With this clarification, we shall now proceed to deal with the questions with reference to the facts arising for the year of assessment 1965-66. Since our decision on the claim for the year of assessment 1965-66 will cover the other two years as well, we shall now refer only to the detailed facts for the year of assessment 1965-66 as seen from the balance-sheet of the company for the year ended on 31st December, 1964, which is the corresponding accounting period for the year of assessment 1965-66.
3. The question that has been referred to us, arises in construing Rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. We consider it best to extract the whole of Rule 2 of the Second Schedule with the Explanations:
'2. Where a company owns any assets the income from which in accordance with Clause (iii) or Clause (vi) or Clause (viii) of Rule 1 of the First Schedule is required to be excluded from its total income in computing its chargeable profits, the amount of its capital as computed under Rule 1 of this Schedule shall be diminished by the cost to it of the said assets as on the first day of the previous year relevant to the assessment year in so far as such cost exceeds the aggregate of-
(i) any moneys borrowed (other than the debentures referred to 'in Clause (iv) or moneys referred to in Clause (v) of Rule 1) and remaining outstanding as on the first day of the said previous year ; and
(ii) the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under Rule 1.
Explanation 1.--A paid up share capital or reserve brought into existence by creating or increasing (by revaluation or otherwise) any book asset is not capital for computing the capital of a company for the purposes of this Act.
Explanation 2.--Any premium received in cash by the company on the issue of its shares standing to the credit of the share premium account shall be regarded as forming part of its paid up share capital.
Explanation 3.--Where a company has different previous years in respect of its income, profits and gains, the computation of capital under Rules 1, 2 and 3 shall be made with reference to the previous year which commenced first.'
4. Turning now to the balance-sheet of the company, it is seen that the amounts that are claimed by the assessee must be taken into account to reduce the value of the assets which are referred to under the first part of Rule 2 of the Second Schedule, namely, assets the income from which is required to be excluded under Clauses (iii), (vi) and (viii) of Rule 1 of the First Schedule. After determining the value of these assets as on the first day of the year of account, Sub-rules (i) and (ii) of Rule 2 provide that the portion of such assets shall be reduced further by the borrowing and particularly under sub-r. (ii), under which the question arises, by any fund, surpluses and reserves which are not to be included for the purpose of Rule 1 of the Second Schedule. On the basis of this provision in Rule 2 of the Second Schedule, the assessee has contended that the following amounts shown in the balance-sheet at page 18, namely, Rs. 24,36,239 under the heading 'Reserves or Contingency Accounts', the sums of Rs. 1,82,346, Rs. 50,709 and Rs. 16,70,197 falling under 'Estimated liability in respect of outstanding claims whether due or intimated 'which amounts sum up to Rs. 19,03,252, as also the provision towards unearned premium and premium deposits of the amounts Rs. 2,40,197 and Rs. 91,510 as seen at page 20 of the balance-sheet falling under the heading 'Liabilities' as well as the sum of Rs. 6,42,524 which is termed as 'Proposed dividend for the year 1964' should be deducted from the value of the assets, the income from which is required to be excluded for the purpose of Rule 1 of the First Schedule in order to arrive at the capital base or the value of the capital assets in relation to which 10% has to be allowed as a statutory reduction.
5. We shall deal with these items one by one. Provision for tax cannot be a reserve for the simple reason that the tax had already accrued due, and a specific liability towards this had arisen. The matter is covered by the decision of the Supreme Court, and, hence, we negative the contention that the sum of Rs. 24,36,239 should be excluded. There is the further sum of Rs. 12,008 mentioned under the heading 'Reserves or Contingency Accounts' and it relates to the profit and loss appropriation account. No particular point was made about this small amount by counsel for the assessee and we do not, therefore, deal with this sum.
6. Now turning to the 'estimated liability in respect of outstanding claims whether due or intimated' totalling Rs. 19,03,252, since these sums are also related to the liabilities of the company arising under fire, marine and miscellaneous insurance, those sums cannot be said to represent reserves. Further, even if these sums are treated as reserves, such reserves will not be 'reserves other than those referred to in Rule 1 of the Second Schedule'.
7. Unearned premium has to be explained. When insurance policies are taken during the course of the accounting period they are often taken for a full year that will overlap the accounting period. Since normally policies are taken under fire and miscellaneous insurance as well as marine insurance for a year, the total premium for the year is received by the insurance company and appropriate entries are made first on the right hand side of the balance-sheet showing the total premium as receipts and an entry made on the left hand side of such amount of premium attributable to the period after that of the accounting year, in order to balance and in order that the document may be a balance-sheet. Necessarily, that portion of the premium which is attributable to the period beyond the accounting period has to be calculated and shown on the liabilities side on the left hand side. The sum of Rs. 2,40,197 is the sum so calculated and shown on the liabilities side. But by no stretch of imagination can this be called as reserve and cannot be taken into account because this amount is also a receipt and shown in the balance-sheet only for the purpose of balancing the account. The total sum of the premium for the full year cannot be treated as the income of the year in question though already taken into account for the purpose of determining the income on the right hand side.
8. A word about the premium deposits. These are amounts made available to the company for the insurance policies that may have to be issued by the company in future. Prudent parties make available to the insurance company fairly large sums of money for the purpose of adjusting the premium payable in future policies to be issued to ensure immediate coverage on request and in order to avoid delay. Such sums shown do not belong to the company. In fact, we consider that they will be amounts held in trust for a specific purpose by the company. They have naturally to be shown in the balance-sheet and they have been rightly, we consider, shown under the heading 'Liabilities' and such amounts cannot be treated as the funds of the company Coming out of its profits. We are aware that monies borrowed by the company may constitute its capital for the purpose of its business, and reserves can be created out of that capital. It may not be a reserve technically but perhaps may be a fund for the purpose of Rule 2(ii) of the Second Schedule. On this aspect, we do not wish to express any opinion in this case, for, we do not think that this money belongs to the company as it is impressed with an obligation in the nature of a trust falling within Chapter IX of the Trusts Act. We, accordingly, disallow the claim that this amount may be taken into consideration for computing the reserve for the purpose of Rule 2(ii) of the Second Schedule.
9. The amount, which has given considerable difficulty, not entirely due to the complicated question, but in view of the number of decisions that had been cited, reference having been made to the other Acts and Schedule and forms, is the sum of Rs. 6,42,524 referred to as 'proposed dividend for the year 1964'. Before we deal with this, we would like to state a few principles, which are indisputable. Reserves, in order that they may be so called under the real sense of the term, must normally come out of the profits of the company. But if reserves are constituted out of assets which are sold or by any other means, it may be difficult to term that the amount shown as reserve is really a reserve. But here again we do not wish to state anything by way of opinion of this court, for, the question does not arise. But we can be more specific and certain that the amounts set apart specifically for the purpose of meeting a specific liability will not be a reserve but will only be a provision made for meeting the specific liability. Therefore, on the first day of the year in question if there has been an accrued liability for the purpose of payment of the dividend notwithstanding the provision made for the payment of that dividend, the sum that has been provided for payment of that dividend will not be treated as reserve. One other principle that we wish to state is that the proposal for payment of the dividend having been made by the board of directors, it is not in fact a present liability by the mere fact that there is such a proposal. The Supreme Court has Ruled for the purpose of the W.T. Act, that the proposal will become an accrued liability only when the shareholders of the company approve of the proposal in the general body meeting of the company. The decision is in Kesoram Industries and Cotton Mitts Ltd. v. CWT : 59ITR767(SC) . We consider that this principle laid down by the Supreme Court is certainly applicable for the purpose of deciding whether on the first day of the year of accounting in question there was an accrued liability for payment of dividend by the company. It was not contended on behalf of revenue that there was any such accrued liability on the first day of the year of accounting. Reference was then made to the decision of the Supreme Court in CIT v. Mysore Electrical Industries Ltd. : 80ITR566(SC) and it was submitted that if appropriation to reserves has been made by the general body it will date back to the first day of the year in question, because it must be taken to be a reserve made on the first day of the year in question. This decision only dealt with the reserves which were for purposes other than the reserves for the purpose of payment of dividends. Therefore, this decision cannot be taken as an authority for the proposition that an appropriation made towards the reserve for the purpose of payment of dividend, apart from making the appropriation later effective from the first day of the year of account, will also create a liability for dividend from the first day of the year of account.
10. The decision in CIT v. Mysore Electrical Industries Ltd. : 80ITR566(SC) , which dealt with certain reserves other than reserves for dividend, andthe decision in Kesoram Industries and Cotton Mills Ltd. v. CWT : 59ITR767(SC) , which specifically dealt with the question of reserves for dividend,which on the date of valuation, were only in the nature of proposal forpayment of dividend, will have to be noticed and applied. If we have toreconcile the two decisions, which dealt with different kinds of reserves, wehave to come to the conclusion that the amounts in question are reservesthat have been made for payment of dividend at the time when there wasonly a proposal made by the directors and, though they have been shown in the balance-sheet as a separate item indicating a specific sum under theheading 'Proposal for dividend', nevertheless remains as a provision forreserve made for the purpose of meeting the contingent liability which mayor may not accrue depending upon the shareholders approving of that proposal of the directors or not. Our attention was drawn to the decision ofthis court in Nagammal Mills Ltd. v. CIT : 94ITR387(Mad) and itwas contended that the decision of this court is an authority for the proposition that a provision made for payment of dividend, the liability for whichmay accrue in future, cannot be considered as a reserve. We do not thinkthat the decision of this court has dealt with this aspect. The decisionnoticed the pronouncement of the Supreme Court in CIT v. Mysore Electrical Industries Ltd. : 80ITR566(SC) and held that the appropriation willdate back to the 1st of May, 1961. Having dealt with the first two items,which do not relate to contingent liabilities, this court observed at page 391 with reference to dividend itself thus :
'Coming to the provision for dividend of Rs. 3,43,485 it is seen that the said dividend has actually been paid out by the company to its shareholders. Though the same was set apart for a specified purpose, it cannot be said to be available for the future use of the company so as to partake the character of capital. The said sum set apart for payment towards a specific liability cannot be said to be a reserve for future use of the company. This sum has, therefore, to be treated as not a reserve.'
11. The provision in Rule 2 of the Second Schedule, which in the main paragraph as well as in Sub-rule (i) specifically refers to the date with reference to which the capital referred to in the first paragraph will have to be computed as well as the date on which the borrowings had to be computed, generally gives the impression that the question as to liability must be considered with reference to that crucial date, namely, first day of the accounting year. This is also clear, it appears to us, from Sub-rule (i) of Rule 2 which in its wake attracts Rule 1 of the Second Schedule which specifically at the beginning refers to that date. It is inconceivable that reserves which fall under Rule 1 must be reserves as on the first day of theyear in question but reserves for the purpose of Sub-rule (ii) of Rule 2 must be with reference to some other date. We consider, therefore, that even for the purpose of Sub-rule (ii) of Rule 2, though Sub-rule (ii) does not specifically refer to any specific date, that date must be the 1st day of the year of account. The question, therefore, is whether any amount shown to represent a dividend proposed by the directors represent any liability for the company from the 1st day of the year of account. Any provision made by way of reserve of an amount for the purpose of a possible liability that may arise in the payment of dividend cannot be refused to be taken into account merely on the ground that the amount represented a provision or a reserve for an accrued liability, as there was no accrued liability as on the relevant date, namely, first day of the year of account. It has been so held by the Supreme Court in Kesoram Industries and Cotton Mills Ltd. v. CWT : 59ITR767(SC) . So, in all these cases, we think, where a proposal has been made by the directors and by virtue of this proposal, a reserve has been made for a possible liability towards dividend, that provision or reserve could not cease to be a reserve on the ground that it is a reserve for the purpose of payment of an accrued liability as on that date. On the facts of the case before us, it has not been contended that the shareholders had approved the proposal as on that date. There is, therefore, no liability to pay that amount as on that date. This aspect was not urged before this court when it decided the case in Nagammal Mills Ltd. v. CIT : 94ITR387(Mad) and the question has not been considered at all in the judgment under consideration. We think, therefore, that the decision cannot be taken to be a precedent for the question which has to be dealt with in this judgment, but can be distinguished, as we propose to do, as a case where the emphasis had been on the payment out of the money which was at one time provided for dividend and in view of the fact that the proposal of the directors was later approved by the shareholders of the company and the money had been actually expended for the purpose. We are not called upon in this case to consider whether payment out during the year of account will deprive the right of an assessee to claim the benefit, for that question does not arise before us, no point having been taken in that behalf. We, therefore, leave that question open to be considered in another appropriate case.
12. In the light of what we have stated above it is clear that the amount provided cannot be said to be not a reserve merely on the ground that it represented a sum set apart for the purpose of meeting a specific accrued liability. But this does not take the assessee very far, because if the amount is a reserve--and we will assume so without deciding the question that it represented merely a provision, and assume again that there is a distinction between a provision for an uncertain and unaccrued liability and a reserve made for meeting any contingent liability--we think that it will be a reserve that will fall under Rule 1 of the Second Schedule. If the amount will fall under Rule 1 of the Second Schedule then the amount cannot be excluded for the purpose of Sub-rule (ii) of Rule 2 and, therefore, the assessee has in any case to fail on this aspect as well. What we have said is enough to dispose of the case completely ; but we have to refer to the contention of the counsel for the revenue who had done investigation with reference to the Explanation to Rule 2 of the Second Schedule and took us through the form of balance-sheet prescribed under the Companies Act. She contended that the dividend is one of the items of liabilities in the form prescribed under the Companies Act and has, therefore, necessarily to be included for the purpose of computing the value of the reserve in determining the value of the capital assets under Rule 1 of the Second Schedule. Counsel for the assessee contended that the Companies Act and the form of the balance-sheet prescribed under that Act will have no application since we are dealing with an insurance company and he invited our attention to Section 11 and the Second Part of the Schedule II to the Insurance Act and contended that the arguments advanced on behalf of the revenue would not lie. This is again a question on which we would not like to express any opinion because if the case can be disposed of on other points, it is a dangerous procedure to express opinion on questions of law which do not directly arise in the case. For the same reason, we do not express any opinion on the applicability of the decision of the Supreme Court in CIT v. Century Spg. and Mfg. Co. Ltd. : 24ITR499(SC) , the decision of the Punjab and Haryana High Court in CIT v. Hindustan Milk Food Mfg. Ltd. , the decision of the Kerala High Court in Aluminium Industries Ltd. v .CIT : 68ITR125(Ker) and the decision of the Allahabad High Court in CIT v. Hind Lamps Ltd. : 90ITR487(All) . It appears to us that these are cases which deal with the facts which are different from the one arising before us. In all those cases, there was no setting apart or making any provision made as reserve at all, as it appears to us on a reading of the judgments, though an argument was advanced that the amounts which were decided to be paid out as profits by way of dividend must be taken as a reserve. We do not consider that aspect now.
13. In the light of the above, we answer the questions for the three years in the affirmative. The revenue will get its costs from the assessee. Counsel's fee Rs. 250.