Sabyasachi Mukharji, J.
1. The assessee is a company incorporated under the Indian Companies Act, 1913. This reference arises out of the procedures under the C. (P.) S.T. Act, 1964, for the assessment year 1964-65, the relevant previous year being the calendar year 1963. As we are concerned with the C. (P.) S.T. Act, 1964, it would be material to refer to certain relevant provisions of the said Act. Section 4 of the said Act stipulates the imposition of tax. It provides that subject to the provisions contained in the said Act, there will be charged on every company for every assessment year commencing on and from the 1st day of April, 1964, a tax in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third Schedule. Section 2(5) of the Act defines chargeable profits as the total income of an assessee computed under the I.T. Act, 1961, for any previous year or years, as the case may be, adjusted in accordance with the provisions of the First Schedule. Section 2(8) provides for 'statutory deduction', as an amount equal to ten per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule or an amount of two hundred thousand rupees, whichever is greater. The First Schedule provides for the rules for computing the chargeable profits. The Second Schedule provides rules for computing the capital of a company for the purposes of surtax. Rule 1 of the Second Schedule provides as follows:
'1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year of--(i) its paid-up share capital ;
(ii) its reserves, if any, created under the proviso (b) to Clause (vi-b) of Sub-section (2) of Section 10 of the Indian Income-tax Act, 1922 (XI of 1922), or under Sub-section (3) of Section 34 of the Income-tax Act, 1961 (XLIII of 1961);
(iii) its other reserves as reduced by the amounts credited to such reserve as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (XI of 1922), or the Income-tax Act, 1961 (XLIII of 1961);
(iv) its debentures, if any ; and
(v) any moneys borrowed by it from Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution which the Central Government may notify in this behalf in the Official Gazette or any banking institution (not being a financial institution notified as aforesaid) or any person in the country outside India. Provided that such moneys are borrowed for the creation of a capital asset in India and the agreement under which such moneys are borrowed provides for repayment thereof during a- period of not less than seven years.
Explanation.--For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7), under the heading 'Reserves and Surplus' or of any item under the heading 'Current Liabilities and Provisions' in the column relating to 'Liabilities' in the 'Form of Balance Sheet' given in Part-I of Schedule-VI to the Companies Act, 1956 (1 of 1956) shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule.'
2. In essence, under Rule 1 of the Second Schedule, the capital of a company is the aggregate of the amounts as on the first day of the previous year, relevant to the assessment year, of the paid-up capital, the reserves and debentures, etc. In the instant case, the previous year was the calendar year 1963. In the premises the position that requires consideration is the position of the capital as on the first day, that is to say, 1st January, 1963. In the assessment under the aforesaid Act, the assessee claimed a sum of Rs. 90 lakhs transferred to the dividend reserve as a reserve entering into the capital computation. The assessing authority excluded this sum from computation of capital. There was an appeal before theAAC. He found that the aforesaid sum was a reserve created out of amounts which had been allowed as deduction in computing the profits of the year. He thus found in effect that the said reserve qualified for inclusion under Rule l(iii) of the Second Schedule of the said Act. He, accordingly, allowed the assessee's contention.
3. There was a further appeal before the Tribunal by the revenue. It was contended that with the transfer of the sum of Rs. 90 lakhs simultaneously to the dividend reserve a sum of Rs. 76 lakhs had been paid as dividends. According, to the revenue, the whole of Rs. 90 lakhs would only be a provision, as it was intended to meet a liability to the shareholders for dividend and, in the alternative, it was urged that the sum of Rs. 14 lakhs could alone be taken as reserve to the exclusion of Rs. 76 lakhs, which was immediately payable as dividend. On behalf of the assessee, the contention urged was that the situation to be considered was as on 1st January, 1963, and as the dividend declared was declared later, the sum of Rs. 76 lakhs could not be treated as a liability on 1st January, 1963, In the premises, it was urged that Rs. 90 lakhs should be treated as a reserve. The Tribunal on the language of Rule 1 of the Second Schedule came to the conclusion that only Rs. 14,00,000 could be taken to have been transferred to the reserve account. The Tribunal, therefore, held that the sum of Rs. 14,00,000 only would be treated as provision and it directed modification of the capital computation accordingly. In the permises, the following question has been referred to this court under Section 256(1) of the I.T. Act, 1961:
'Whether, on the facts and in the circumstances of the case, the sum of Rs. 76,00,000 appropriated for dividend at the annual general meeting held on 31st day of May, 1963, could be taken into account as reserve for the computation of capital as on January 1, 1963, under Rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'
4. In order to determine this question it would be relevant to refer to certain facts as appearing from the order of the Tribunal and from the balance-sheet. It appears that on the 1st May, 1963, in respect of its accounts for the year 1962, the assessee-company in the directors' meeting approved the transfer of a sum of Rs. 90,00,000 out of the profits for the year to a dividend reserve account. Thereafter, on the 3rd May, 1963, the directors recommended payment of a dividend out of the 'dividend reserve account' of 12 1/2%, which amounted to Rs. 76,00,000 on the ordinary shares, on the amount paid on those shares prior to 31st December, 1962. On 31st May, 1963, in the general meeting the accounts were passed by the shareholders and the dividend as recommended by the directors was declared. Subsequently, the dividend thus declared was paid later on and it was adjusted by transferring the sum of Rs. 76,00,000 from the dividendreserve account through the profit and loss appropriation account. In the annual report for the year 1962 (to be placed at the general meeting), due to be held on 31st May, 1963, it was stipulated that one of the agenda was to consider the company's audited balance-sheet as on 31st December, 1962, and the profit and loss account as on 31st December, 1962. Another agenda included the declaration of dividend. In the report of the directors for the year ending 31st December, 1962, presented to the shareholders for the meeting to be held on 31st May, 1963, para. 5 provides as follows:
Since at the meeting of the directors, at which the above appropriations were made, further consideration has been given to the position created by the recent tax measures introduced by the government and the directors now recommend the payment of a dividend out of the dividend reserve at the rate of 12 1/2% on the ordinary shares on the amounts paid up on these shares prior to 31st December, 1962 the dividend will be paid after deduction of tax at the appropriate rate.'
5. In this report it was stated that the auditors' report presented the company's affairs as on 31st December, 1962, and its profits for the years ended on that date. In the balance-sheet under the heading 'Liabilities' as on 31st December, 1962, under the sub-heading 'Provisions' there is an item called 'Item (c)--Proposed Dividend' which shows the figure to be 'nil'. The Schedule forming part of the balance-sheet under the head 'Reserves and Surplus' under item (e) of the Dividend Reserve Account stated that the transfer from the profits and loss account was Rs. 90,00,000.
6. The question, therefore, is whether under the Act this sum of Rs. 90,00,000 or any part thereof can be taken as reserve in computing the capital as on 1st January, 1963. In this connection, it has to be borne in mind that the purpose of the C. (P.) S.T. Act, as the preamble itself stated, was to impose a special tax on the profits of certain companies. Therefore, it was an Act intended to impose tax on the profits of the company, and for this purpose a certain amount of deduction was allowed according to certain rules for the computation of profits as indicated. In that computation of profit the capital or reserve forming the capital of the company had to be excluded. That purpose has to be borne in mind in considering the controversy in this case. It is true that according to the entry in the balance-sheet as on 1st January, 1963, the sum of Rs. 90,00,000, was in its entirety taken as 'reserve to the dividend reserve account'. Counsel for the assessee contended that it was like a reserve for any contingency that had arisen. The contingency or liability to pay dividend, according to the counsel for the assessee, arose subsequently. It might have been two or three days later but not on the 1st January, 1963. In this connection, emphasis was laid, as indeed it should be laid, on thewording 'as on first day of the previous year' appearing under Rule 1 of the Second Schedule to the Act. It was submitted that the rule made it clear that we have to consider the position as on the first day of the previous year, whether the reserve was there or not. If the reserve was there as on that date then subsequent liability or subsequent transfer would not in any way alter the position. In this connection, reliance was placed on the decision of the Supreme Court in the case of Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC . There, one of the questions with which the Supreme Court was concerned was whether the appropriation amounted to a reserve or provision. The Supreme Court was dealing with the question of payment of bonus to the workers and appropriation on that account. At pp. 62 and 63 of the report, the Supreme Court observed that the distinction between a provision and a reserve was in commercial accountancy fairly well known. Provisions were made against anticipated losses and contingencies were charged against profits and, therefore, had to be taken into account against gross receipts in the profit and loss account and balance-sheet ; on the other hand, reserves were appropriation of profits, the assets by which these were represented being retained to form part of the capital employed in the business. Provisions were usually shown in the balance-sheet by deduction from the assets in respect of which these were made, whereas general reserve and reserve fund were shown as part of the proprietor's interest. An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in the value of assets known to exist at the date of the balance-sheet, was a reserve but an amount set aside out of profits and other surpluses which was provided for a known liability for which the amount could not be determined with substantial accuracy was a provision. Relying on the aforesaid observation of the Supreme Court, it was contended by the counsel for the assessee that, in this case, Rs. 90,00,000 was not a provision for payment of liability but it was a reserve taken out of the profits and as such formed part of the capital of the company as on the first day of the previous year, i.e., on the 1st January, 1963. Counsel submitted that on that date there was no liability known or unknown for payment of any dividend and as such this could not be treated as provision for payment of any liability for the payment of dividend. The position of the passing of the accounts and as to how it should relate back has been explained by a judgment of the Bombay High Court in the case of CIT v. Aryodaya Ginning and . : 31ITR145(Bom) . There, what happened was that a limited company made up its accounts at the end of December every year. For the year ending December, 1948, the directors made certain appropriations of the profits ofthat year and profits brought forward from the previous year and allocated certain amounts to the reserve fund and the dividend reserve fund. At a general meeting held on 27th June, 1949, the shareholders of the company accepted the recommendation of the directors and passed the balance-sheet. In the assessment of the company to business profits tax for the chargeable accounting period January 1, 1949, to March 31, 1949, under the B.P.T. Act, 1947, the company claimed that the amounts allocated to the reserve fund and the dividend reserve fund should be taken into account in computing, for the purpose of abatement, inasmuch as these reserves appeared in the balance-sheet as on December 31, 1948. The I.T. authorities contended that as the reserves were not sanctioned by the shareholders till June 27, 1949, these could not be treated as reserves for the chargeable accounting period of January 1, 1949, to March 31, 1949. It was held by the Division Bench of the Bombay High Court that as the shareholders had by their resolution of June 27, 1949, decided not only that these amounts should constitute reserves but also these amounts should constitute reserves of the company as of 31st December, 1948, and the profits out of which these amounts were reserved were profits made by the company before January 1, 1949, and the reserves were in existence on that date and could have been utilised for the working of the company as much as the capital, during the chargeable accounting period, the amount transferred to the reserve fund should be taken into account in computing the capital for the purpose of allowing abatement for the relevant accounting period.
7. This position has been made abundantly clear by the language used in Rule 1 of Schedule II of the present Act, with which we are concerned. The Supreme Court in the case of CIT v. Mysore Electrical Industries Ltd. : 80ITR566(SC) observed that, there, out of the profits of the respondent-company for the accounting year ending 31st March, 1963, the directors of the company appropriated the following amounts towards the reserves on the 8th August, 1963, Rs. 2,56,000, as plant modernisation and rehabilitation reserves and Rs. 1,00,000, as loss repatriation reserve and Rs. 89,557 as development rebate reserve. The question was whether these amounts could be included in computing the capital of the respondent as on the 1st April, 1963, under Rule 1 of Schedule II to the C. (P.) S.T. Act, 1964, for the purpose of the statutory deduction for the assessment year 1964-65. The department contended that since the appropriations were made on August 8, 1963, these could not be treated as components of capital as on the 1st day of the previous year, namely, the 1st April, 1963. It was held by the Supreme Court rejecting the contention of the department that the determination of the directors to appropriate the amounts to the three items of reserves on August 8, 1963, had to be related back to April 1, 1963, namely, the beginning of the accounts for the new year, and had to betreated as effective from that day. The three items had to be added to other items for the computation of the capital of the respondent as on the 1st April, 1963, under Rule 1 of Schedule II of the present Act.
8. In the instant case, the directors' report, as we mentioned above,recommended the creation of a reserve and also recommended the declaration of a dividend of Rs. 76,00,000. The proximity of the directors' meeting recommending the creation of reserve, declaration of dividend andsimultaneous passing of the two items at one meeting indicated that thesereserves, in our opinion, were intended for the payment of the liabilityintended to be created as on the 1st January, 1963. It is true thatactually that liability was created subsequently but the liability wasintended to be created in order to be related back to the 1st January,1963. Therefore, those two items are in our opinion part of an integratedtransaction, as the Tribunal has observed that these two transactions hadto be read as integrated transactions. The Tribunal has observed that theentries might be made by transferring an ad hoc amount to the generalreserve and appropriating the required amount for distribution of dividends out of the amounts found in the dividend reserve. Another waywas to appropriate out of the profits of the relevant year the requisiteamounts of dividend and to take the unappropriated balance or part thereof to the reserve account. In this case, the same report which had recommended the passing of the account as on the 1st January, 1963, alsorecommended the declaration of dividend of Rs. 76,00,000. Therefore, thesehad to be treated as part of one transaction. This was one of the methodspermissible by law and by principles of accountancy, which the assessee hadadopted, but the purpose of the reserve was earmarked for the purposeof creating a liability intended to be effected more or less simultaneouslywith the creation of the reserve in that account and having regard tothe purpose of the Act. We are, therefore, of the opinion, that the Tribunal came to the correct conclusion on this aspect of the matter.
9. In the aforesaid view of the matter, the question referred to this court is answered in the negative and in favour of the revenue. Each party will pay and bear its own costs.
10. I agree.