BALASUBRAHMANYAN J. - The question of law for our decision in these income-tax reference has to do with a particular aspect of computation of the profits of a general insurance business. The I.T. Act, 1961, provides for special rules of computation of profits of general insurance business. The rules are laid down in Part B or the First Schedule to the Act. Rule 5 takes as the basis of computation the figures of the balance of profits as of Insurance. Rule 5, however, proceeds to law down certain special provisions of deductions from the figure of the balance of profits shown in the annual accounts. The special provisions in r. 5 only means that the ITO cannot tinker with the figure found in the assessee annual accounts except to the extend allowed by cls. (a) to (c) of r. 5 of the First Schedule.
The assessee in these cases is a general insurance company. It had considerable investment in joint stock company shares and the like. They were being held by the assessee over a period of time. Of those investment some appreciated in value and so depreciated in value. In making up its annual accounts for the year ended December 31, 1965 (relevant to the assessment year 1966-67), the assessee displayed its investment in its balance-sheet. As on that date, some of the investment had registered a decline in value, and some had registered an appreciation in value since the first day of the account year. But in point of accounting, the assessee did not follow a uniform method in respect of these variations in value during the account year. On the one hand, as respect investment which had depreciated in value, the assessee wrote off the amounts by which the investment had fallen in value. On the other hand, as respects investment which had appreciated in value, the assessee did not write up their value to accord with the position as at the close of the account year, but retained their lower value as at the beginning of the account year.
The amounts which the assessee wrote off in its accounts for the year ended December 31, 1965, on account of investment which had deprecated in value was Rs. 4,52,510. The appreciation in value of certain other investment, which appreciation the assessee studiously avoided bringing into account, amounted to Rs. 2,22,083. Be it again noted that their amount of appreciation in the value of certain investment had not been taken into account at all in the assessees annual accounts.
When the matter of computation for income-tax purposes of the years profits came up, the assessee claimed that it was entitled to deduct the amount of Rs. 4,52,510 being the amount written off in the books, on account of depreciation of investment which had depreciated value since the last accounting period. The ITO, however, refused to grant the deductions to the entire extent written off, but set off against that amount the sum of Rs. 2,22,083 representing the value by which certain other investments held by the assessee has appreciated in value in the courses of the year. In effect, therefore, the ITO, allowed a deduction not for the whole amount of Rs. 4,52,510 but only for Rs. 2,30,427 after set off against Rs. 4,52,510 the sum of Rs. 2,22,083.
The assessee appealed against this computation. The Tribunal before whom the assessment ultimately came up for consideration held that the ITOs action was not warranted under r. 5 of the First Schedule to the I.T. Act.
The matter has now been brought on reference by the Commissioner Mrs. Nalini Chidambaram, the learned junior standing counsel for the I.T. Dept., urged that the Tribunal had not property appreciated the basis of the ITOs action, and, understood aright, his action ought to have been upheld as being in compliance with the relevant rule. Before proceeding to examine this contention, we may refer to the phraseology of r. 5 of the First Schedule to the Act. The relevant portion of r. 5 is contained in cl. (b). The clauses has an enacting part and also a proviso. Both real as under:
'5. Computation of profit and gains of other insurance business-'The profits and gains of any business of insurance other than life insurance shall be taken to be the balance of the profits disclosed by the annual accounts, copies of which are required under the Insurance Act, 1938 (IV of 1938), to be furnished to the Controller of Insurance, subject to the following adjustment:-......
(b) any amount either written off or reserved in the accounts to meet depreciation of or loss on the realization of investment be allowed as a deduction, and any sums taken credit for in the accounts on account of appreciation of or gains on the realization of investment shall be treated as part of the profits and gains:
Provided that the Income-tax Officer is satisfied about the reasonableness of the amount written off or reserved in the accounts, as the case may be, to meet depreciations of or loss on the realization of investment.'
Clauses (b) of r. 5 lays down how the valuation of investment in the accounts of a general insurance business have got to be dealt with for purposes of assessment to income-tax. The enacting part of r. 5(b) consists of two distinct subjects (i) depreciation of, or loss in realization of, investment: and (ii) appreciation of, or gains on the realization of, investments. As to the first contagions, the rule says that any amount either written off or reserved in the accounts to meet depreciation of, or loss on the realization of, investment shall be allowed as a deduction. As to the second subject relating to the appreciation of or gains on the realization of investment, the rule requires that any sums taken credit for in the accounts on accounts of appreciation of investment, or gains on the realization of the investment, shall be treated as part of the assessable profits and gains of the insurance business. It is clear, therefore, that the prime requirement of either allowance of loss or depreciation of investment, on the one land, or the charging of profits on the appreciation of investment on the other, can only be done if either result, is actually reflected in the accounts of the insurance business as furnished to the Controller of Insurances and not otherwise. If, for instance, the loss of investment or depreciation of investment is not reflected in the accounts, then the assessee cannot claim any deduction, even though in point of actual fact the investment have registered a decline as between the first day of the account year and its closing day. Likewise, where the investment register a rise in value during the account year, the value of that appreciation or actual realization, as the case may be, cannot be brought to assessment as part of the taxable increment unless the appreciation has been actually brought to account.
The proviso to r. 5(b) has thus got to be construed in the light of the substantive provision which we have earlier set out and the effect of which we have sum, arises, as respects the two distinct subjects namely, the case of depreciation of investment, on the one hand and the case of appreciation of investment, on the other. A look at the proviso, however, makes it quite clear that it is confined strictly to the case of depreciation or loss on the realization of investments. The proviso has nothing whatever to decided on with appreciation in the value of investments, or realization of gains on investment. In the context of a claim for depreciation or loss on the realization of investment which, as we have earlier seen, must be backed up by actual entries reflecting that position in the accounts, which is the only concern of the proviso to r. 5(b), the proviso grants a discretion to the ITO to limit the amount to be deducted on account of loss or depreciation in the value of investment, on the basis of what he considers to be a reasonable deductions. The proviso does not mention what the extent of reasonableness, is, but quite consistent with the concern of the rule, that has got to be determined in accordance with the exigencies of the business and other relevant considerations, if any. We are not concerned in these cases with the question whether the extent to which there ITO has cut down the loss in investment in his orders can be justified on the test of reasonableness. For the assessees contention is more fundamental. It was always been that the action taken by the ITO in these cases does not really fall within the ambit of the proviso at all. It was urged before the Tribunal that the power of the ITO under the proviso if properly exercised only when he addresses his mind to the amounts actually written off in the accounts. That amount, by definition, would only relate to a factual depreciation of such investment as had depreciated in value during the account year. The point urged before the Tribunal by the assessee was that the ITO has had no criticism to offer in his assessment orders as respects the evaluation by the assessee of the extent to which investment which has actually depreciated had registered a decline. The officer had not said a word about the quantum of fall in the value of the investments. He had nowhere taken the position that the depreciating investments had not depreciated to the extent of Rs. 4,52,510. All that the ITO did was that even though this amount was the loss in so far as the depreciation had occurred in the investment in question, yet the amounts cannot be allowed in toto, since there were other investment held by the company which had registered an increase in value and, therefore, the depreciation in investment amounting to Rs. 4,52,510 must be cut down to size, after setting off the amount of appreciation registered by the other investment.
It was this position of the Department which had been rejected by the Tribunal in its order under reference. The Tribunal observed that under r. 5(b), the proviso empowered the ITO only to go into the question of reasonableness of the amount written off to meet depreciation on investment. They observed that depreciation of investment and appreciation of investment were dealt with by r. 5(b) distinctly and separately. They further observed that in view of the scheme of this rule, the ITO has to ignore the appreciation of investment if they had not been brought to account, but can only adjudicate one reasonableness of the depreciation of investments. In so far as the ITO had taken note of the appreciation of investments, his action, according to the Tribunal, amounted to interfering with the item of appreciation of investments. It was on the basis of this reasoning that the Tribunal held that the entire loss written off in the sum of Rs. 4,52,510 must be granted as a deductions in the computation of the assessees investments.
In our judgment, the Tribunal has properly understood the provisions or r. 5(b) of Sch. I to the I.T. Act. We are further of the view that the Tribunal was right in understanding the real basis of interference by the ITO in the figure of profits disclosed by the assessee in its annual accounts. We may add that to the extent that the ITO had set off the figure of appreciation of investments, namely, Rs. 2,22,083 against the loss in depreciation of investments, namely Rs. 4,52,510, the ITO was really adding the amount of appreciation of investment to the profits disclosed by the assessee annual accounts, when such appreciation has not found its way or been truly reflected in its accounts. In our judgment, the fact that in certain other investment of the assessee there has been an appreciated in value, is not a consideration which is germane for testing the reasonableness of the depreciation in value of certain other investments, although in a global view of the entire investment schedule of the assessee it might be possible to set off the depreciation in one set of investment as against the appreciation in another set of investment. But r. 5(b) does not empower the ITO to take such a global view.
The learned junior standing counsel for income-tax referred to a decision of the Calcutta High Court in Calcutta Insurance Ltd. v. CIT : 21ITR404(Cal) . That case had to with the assessment of profit of a life insurance business, and with the special rules of computation enacted in the schedule to the Indian I.T. Act, 1922, for ascertaining the assessable profits of life insurance business. A reference to the schedule to the said I.T. Act, 1961, would readily reveal the difference in approach to the problem of computation as between the profits of a life insurance business, on the one hand, and the profits of business of insurance other than life insurance, on the other hand. We have earlier referred to r. 5 of the First Schedule which we have discussed in the foregoing paragraphs. Part B of the First Schedule to the present Act is concerned with rules of computation of profits from other insurance business, whereas Part A of the first Schedule relates to the computation of profits from life insurances business. A reference to r. 3 which occurs in Part A shows that discretion is granted to the ITO to interfere with the actual figures in the accounts whether those figures represent writing down of the value of depreciating investment, or the writing up of the value of appreciating investment in a life insurance business. The discretion of the ITO in this regard is laid down in proviso to r. 3(b) which is in the following terms:
'Provided that if upon investigation it appears to the Income-tax Officer after consultation with the controller of Insurance that having due regard to the necessity for making reasonable provision for bonuses to participating policy-holders and for contingencies, the rate of interest or other factors employed in determining the liability in respect of outstanding policies is materially inconsistent with the valuation of investment so as artificially to reduce the surplus, such adjustment shall be made to the allowance for depreciation or to the amounts to be included in the surplus in respect of appreciation of such investment as shall increase the surplus for the purposes of these provision to a figure which is fair and just.'
The above proviso is a repetition, word for word, of the proviso to r. 3(b) of the Schedule to the Indian I.T. Act, 1922, which was construed and applied by the Calcutta High Court in the Calcutta Insurances case : 21ITR404(Cal) . It is quite clear from the terms of this proviso that the ITO can make his 'adjustment' both with reference to appreciation of investment and with reference to the depreciation of investments. It may be further observed that under the Schedule to the Indian I.T. Act, 1922, the ITO was conferred a similar discretion, having the same amplitude, even in the matter of computation of profits from an insurance business other than a life insurance business. This is made clear by the working of r. 6 of the Schedule to the Indian I.T. Act, 1922, which is in the following terms:
'... Profits and losses on the realization of investments and depreciation and appreciation of the value of investment shall be dealt with as provided in rule 3 for the business of life insurance.'
The Calcutta decision as we pointed out earlier, is a direct decision only as to the computation of profits of a life insurance business under r. 3(b) of the Schedule to the Indian I.T. Act, 1922. We would imagine that if a similar problem had arisen under the same Act in regard to the computation of a general insurance business, the result would have to be the same as in the decision rendered in that case, since r. 6 adopted without change, the proviso to r. 3(b) of the Schedule to the Indian I.T. Act, 1922.
In the case before the Calcutta High Court, the ITO had taken a global view of the changes in the valuation of investment of a life insurance business during an intervaluation period, and made his own assessment of the net result of the changes. Accepting this position, the learned judges observed as follows (p. 448 of 21 ITR):
'In the present case, although during the last valuation period, there was depreciation of some of the securities, appreciation of other securities was to a much larger extent so that the net result was a substantial increase of the money invested in securities... On general grounds too it is clear that since the Schedule is concerned with the computation of profits of the last valuation period, there is no reasons why in rule 3(b) it should provide for deduction of any amount as loss where in fact no loss occurred.'
Apart from the last remarks based on 'general' principles, we agree, will respect, with the position laid down by the learned judges. That will hold good for application of r. 3(b), in the First Schedule to the present I.T. Act, 1961, which deals with computation of profits from life insurance business. As we suggested earlier, the same proposition might apply to the computation of profits of general insurance business under the Indian I.T. Act, 1922. But the principle of global assessment of changes in the value of securities, which the above rules incorporate, cannot be extended to the computation of the profits of general insurance business under Part B of the First Schedule to the present I.T. Act, 1961. This is because r. 5(b) of the First Schedule as well as its proviso are a departure from the other rules of computation.
We may now proceed to formulate out answer to this set of references by taking the questions of law in convenient groups and entering our formal answers thereto. In T.C. Nos. 333 and 334 of 1977, the questions of law for out consideration are as follows:
'1. Whether, on the fact and in the circumstances of the case, the Appellate Tribunal was right in deleting the addition representing the appreciation in the value of shares/investments held by the assessee, made by the Income-tax Officer under the second part of roil 5(b) of the first Schedule to the Income-tax Act, 1961 ?
2. Whether, the interpretation given by the Tribunal to rule 5(b) of the First Schedule to the Income-tax Act is valid in law ?'
For the reason we have elaborated in the earlier paragraphs, out answers to these questions is in favour of the assessee.
In T.C. No. 1659 of 1977 similar question have been referred as questions Nos. 2 and 3, which are as follows:
'1. Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in deleting the addition representing the appreciation in the value of shares-investments held by the assessee, made by the Income-tax Officer the second part of rule 5(b) of the First Schedule to the Income-tax Act, 1961 ?
2. Whether the interpretation given by the Tribunal to rule 5(b) of the First Schedule to the Income-tax Act is valid in law ?'
We must return an affirmative answer in favour of the assessee for these two questions as well. In this very tax case, T.C. No. 1659 of 1977, there is an additional question which calls for our consideration and decision. That question is as follows:
'Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the benefit under section 85 and 85A should be granted with reference to the gross dividend income without deducting proportionate management expenses ?'
It is, however, unnecessary for us to dilate on this matter since there is a direct decision of the Supreme Court in Cloth Traders (P.) Ltd. v. Addl. CIT : 118ITR243(SC) , which covers the case. Following that precedent, the above question of law is answered in the assessee favour and against the Revenue.
Having regard to the results of the references, the assessee is entitled to its costs. Counsels fee Rs. 500 (one set).