RAMASWAMI J. - The following question has been referred under section 256(1) of the Income-tax Act :
'Whether, on the facts and in the circumstances of the case, the amount of development rebate in excess of the statutory percentage required to be made under the Income-tax Act is part of the accumulated profits of the company within the meaning of section 2(22)(e) of the Income-tax Act ?'
The assessee is the governing director of a private limited company called Sri Karthikeya Spinning and Weaving Mills Private Ltd., Coimbatore. During the year ending December 31, 1961, which is the accounting year of the company, the assessee had drawn a sum of Rs. 71,792. These drawings were conceded to be the loans or advances from the company. The balance-sheet of the company on December 31, 1961, disclosed a sum of Rs. 3,35,462.50 under the heading 'Development Rebate Reserve' as per the last balance-sheet and a sum of Rs. 1,41,035 as provision made in that account during the year. There was a sum of Rs. 29,265.27 under the heading 'Balance in the profit and loss account'. The development rebate reserve at the beginning of the year was in excess of the statutory percentage required to be made under the Income-tax Act by Rs. 98,827. The Income-tax Officer in making the assessment for 1962-63, relevant to the previous year ending March 31, 1962, of the assessee applied the provisions of section 2(22)(e) of the Income-tax Act, 1961, and assessed a sum of Rs. 71,792 as 'deemed dividend' on the ground that the development rebate reserve formed part and parcel of the accumulated profits within the meaning of that clause. On appeal by the assessee, the Appellate Assistant Commissioner was of the view that the development rebate reserve cannot be treated as accumulated profit on the ground that the reserve was created for a specific purpose and under the provisions of the Income-tax Act, 1961, no advance or loans can be given out of the reserve and that, therefore, the amount will not be available for distribution of dividends. In that view, he held that the said sum of Rs. 71,792 was not liable to be treated and taxed as divided under section 2(22)(e).
On appeal, preferred by the department against that order, the Tribunal held as follows :
'In our opinion a reserve made towards the development rebate to the extent it is not required to be made under the Income-tax Act, is a free reserve and would form part of the accumulated profits. There is no statutory provision to charge the amount of development rebate to profit and loss account. It is not a charge on the profit. It is only an appropriation of profit. In this respect it differs from depreciation. There can be no restriction in the use of such a reserve. Under the Indian Income-tax Act, a reserve of 75% of the rebate actually to be allowed has to be made and this could not be used by the assessee. It can be said that only to this extent that the reserve is tied up. It is seen from the computation given by the departmental representative that the provision of Rs. 3,35,462 is in excess of this statutory provision by Rs. 98,827. There is also a balance of Rs. 29,265 to the credit of the profit and loss account. We, therefore, consider that the sum of Rs. 71,792 is fully covered by the accumulated profits and is to be treated as dividend as defined under section 2(22)(e).'
In this reference, the learned counsel for the assessee contended that the entirety of the development rebate reserve is a specific reserve and no part of it could be distributed as dividend, that there is no warrant for the artificial breaking up of this reserve as 75% which is required to be made under the Act as 'tied-up reserve' and the remaining as a 'free reserve', that the development rebate reserve is an expenditure or an outgoing and is debited to the profit and loss account and not to the profit and loss appropriation account and that since the reserve did not form part of the distributable profit it cannot be treated as an accumulated profit.
Section 33 allows a deduction, subject to the provisions of that section and of section 34, of a sum by way of development rebate. The percentage of such deduction is provided in clause (b) of sub-section (1) of that section. Under section 34(3) the deduction shall not be allowed unless the amount equal to 75% 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. If within a period of eight years the reserve is utilised for distribution by way of dividends or profits in breach of the provisions contained in section 34(3), the rebate would be withdrawn by amending under section 155(5), the assessment for the year for which the rebate was granted. There are other conditions and limitations relating to this reserve which need not be particularly noted for the purpose of deciding this case. It will thus be seen that there is no ban on distribution of this reserve by way of dividends or profits, but if the reserve is distributed then the assessment for the year for which the rebate was grated is liable to be amended under section 155(5) as if the development rebate originally allowed was wrongly done. Even the limitation placed against distribution of the reserve as dividend was only operative for a period of eight years from the year in which the rebate was created. It may also be mentioned that if dividend was declared from the said reserve such declaration was not invalid - the only consequence being the assessment is liable to be amended. Even the limitations placed in sections 34(3) and 155(5) are against the use of the said reserve for certain purposes and not for all purposes. We are, therefore, of opinion that the development rebate reserve is not a tied-up reserve. Under the very terms of section 34(3) the development rebate reserve could be used for the purposes mentioned therein.
It is true that the amount allowable as development rebate is debited to the profit and loss account and not to the profit and loss appropriation account, but it is not correct to state that it is an expenditure or an out-going. For ascertainment of the true profits earned by the company the development rebate is not one of the deductible items. Development rebate is only an allowable deduction in the profit and loss account and not intended to set off as any loss or expenditure incurred by the company. In this connection, we may also refer to the decision of the Bombay High Court in Commissioner of Income-tax v. P. K. Badiani, wherein the learned judges, after a comparison of the nature of depreciation allowance with development rebate, came to the conclusion that the development rebate is not intended to replace any capital loss by wear and tear or in any such other way and that, therefore, it forms part of the real profits and even after it is allowed as a deduction under section 10(2) (vib) of the Income-tax Act, 1922, it continued to retain its original character of profits. Even depreciation reserve has been held to be part of accumulated profits available for distribution in a case arising under section 2(6A) of the Income-tax Act in Commissioner of Income-tax v. Bibhuti Busan Dutt.
Whether it is accumulated profit or not depends normally on the question whether it was a transfer of the profits. Unless the profit is capitalised in some form or other, mere transfer of the profits to any reserve account will not take away from profits the character of accumulated profits-vide the decision in Commissioner of Income-tax v. K. Srinivasan. We have, therefore, no doubt that accumlated profits referred to in section 2(22)(e) includes the amounts in the development rebate reserve.
The learned counsel for the assessee is well-founded in his contention that the artificial breaking up of the development rebate reserve into 75% of the reserve statutorily required to be made under the Act and the rest of the reserve and treating the 75% of the reserve alone as tied-up reserve is incorrect. But, we cannot accept the contention of the learned counsel for the assessee that any portion of the development reserve was a tied-up reserve, so to say, which could not be distributed as dividend. In our opinion, the entirety of the development rebate reserve is a free reserve and an accumulated profit. We may also add that our view is supported by the decision of the Bombay High Court in Commissioner of Income-tax v. P. K. Badiani. A fortiori the development rebate in excess of the statutory percentage required to be made under the Act is part of the Accumulated profits.
Accordingly, we answer the reference in the affirmative and against the assessee with costs. Counsels fee Rs. 250.