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Braithwaite and Co. (India) Ltd. Vs. Commissioner of Income-tax - Court Judgment

LegalCrystal Citation
SubjectDirect Taxation
CourtKolkata High Court
Decided On
Case NumberIncome-tax Reference No. 262 of 1969
Judge
Reported in[1978]111ITR729(Cal)
ActsSuper Profits Tax Act, 1963 - Schedule - Rule 1
AppellantBraithwaite and Co. (India) Ltd.
RespondentCommissioner of Income-tax
Appellant AdvocateR.N. Bajoria, Adv.
Respondent AdvocateSuhas Sen and ;A.K. Sen Gupta, Advs.
Cases ReferredIndian Steel & Wire Products Ltd. v. Commissioner of Income
Excerpt:
- a.n. sen, j.1. in this application under section 256(1) of the income-tax act, 1961, read with section 19 of the super profits tax act, 1963, the following questions of law have been referred to this court : '(1) whether, on the facts and circumstances of the case, the tribunal was right in allowing the claim for deduction of the annual sum of rs. 4 lakhs only to the extent allowed by it in the corresponding income-tax appeal (b) whether the tribunal was right in not treating the following three items as 'reserve' within the meaning of rule 1 of the second schedule to the super profits tax act, 1963, for the purpose of computing the capital of the assessee-- (a) provision for taxation (b) proposed dividend (c) provision for bonus? '2. in view of our decision in income-tax reference no......
Judgment:

A.N. Sen, J.

1. In this application under Section 256(1) of the Income-tax Act, 1961, read with Section 19 of the Super Profits Tax Act, 1963, the following questions of law have been referred to this court :

'(1) Whether, on the facts and circumstances of the case, the Tribunal was right in allowing the claim for deduction of the annual sum of Rs. 4 lakhs only to the extent allowed by it in the corresponding income-tax appeal

(b) Whether the Tribunal was right in not treating the following three items as 'reserve' within the meaning of Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, for the purpose of computing the capital of the assessee--

(a) provision for taxation

(b) proposed dividend

(c) provision for bonus? '

2. In view of our decision in Income-tax Reference No. 169 of 1969 [Braithwaite & Co. (India] Ltd. v. Commissioner of Income-tax : [1978]111ITR542(Cal) ] covering the question No. 1, raised in the present reference, we must hold for reasons stated in our judgment in the said reference that the Tribunal was not right in allowing the claim for deduction of the annual sum of Rs. 4 lakhs only to the extent allowed by it in the corresponding income-tax appeal and the said question is accordingly answered in the negative, against the department and in favour of the assessee.

3. In view of our decision in the said reference, the first question has not been any further argued in the instant reference.

4. The facts of the case relating to the question No. 2, with which we are now concerned in the present reference, have been set out in the statement of the case and the same may be briefly indicated. The statement of the case relates to the assessment year 1963-64 for which the previous year concerned is the calendar year 1962. For the purpose of computing the chargeable profits of the assessee-company, the Super Profits Tax Officer adopted as a starting point the total income as computed for the income-tax assessment, namely, Rs. 1,25,90,78-5, and computed the chargeable profits at Rs. 42,59,972 under Section 4 of the Super Profits Tax Act. Super profits tax is leviable in respect of so much of its chargeable profits of the previous year as exceed the 'standard deduction.' Under Section 2(g), 'standard deduction' means an amount equal to 6% of the capital of the company as computed in accordance with the provisions, of the SecondSchedule. Under Rule 1 of the Second Schedule, the capital of a company shall be computed as on the first day of the previous year, i.e., as on 1st January, 1962, and shall be the aggregate of, (1) its paid up share capital, (2) the amount in its development reserve amount, and (3) other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purpose of the Income-tax Act. The Super Profits Tax Officer computed the capital of the company as under :

Rs.Rs.

Paid up capital 56,59,790 Addition to preference capital 3/12ths of Rs. 40,00,000 10,00,000 General reserve 63,50,000 Development rebate reserve 10,34,450

1,40,44,240Standard deduction being 6% of the above 8,42,654

5. Before the Super Profits Tax Officer the assessee claimed that thefollowing four items should also be included in the computation of capitalbase as 'reserves ' :

Rs.

(1)Provision for taxation32,25,000(2)Proposed dividend14,14,948(3)Provision for gratuities 7,00,000(4)Provision for bonus21,77,750

6. The Super Profits Tax Officer did not allow the said claim of the assessee.An appeal was preferred to the Appellate Assistant Commissioner againstthe order of the Super Profits Tax Officer. The Appellate Assistant Commissioner directed that the total income for income-tax purposes, asreduced in appeal, should be made the starting point for arriving at thechargeable profits. The Appellate Assistant Commissioner confirmed theSuper Profits Tax Officer's action in treating the four items appearing asprovision for taxation, gratuities, bonus and proposed dividend as not forming part of the reserves. Against the said order of the Appellate AssistantCommissioner the assessee preferred a further appeal to the Tribunal. TheTribunal in its order held that as regards the provision for taxation, provision for dividend and provision for bonus, the sums mentioned could not beconsidered to be reserves and: the Tribunal agreed with the authoritiesbelow that these did not constitute reserves. The Tribunal, however, asregards the provision for gratuity, held that the balance in this account ofRs. 5 lakhs as on 1st January, 1961, should be treated as part of thereserves. The Tribunal in its order observed :

'The balance-sheet for the year 1962 was drawn up in May, 1963. So we have to go back to the accounts of the calendar year 1961 and see what are the reserves to be considered as on 1st January, 1962. The balance-shoot for that year was drawn up in March, 1962, and considered by the directors in the general meeting thereafter. Therefore, the appropriations' out of profits being after 1st January, 1962, have not to be taken into account.'

7. The Tribunal held :

'The Income-tax Officer has taken into account, apart from share capital, general reserves of Rs. 63,50,000 and development rebate reserve of Rs. 10,34,450 only. The provision for taxation is not really a reserve and it has rightly been treated as having been set aside to meet a definite liability. It is now well settled that liability to tax arises on the last date of the previous year ; consequently the provision for taxation has rightly been treated as not a reserve.

There was an item of proposed dividend of Rs. 14,14,948 in the balance-sheet as on 31st December, 1960. We take it that this dividend would have been paid during the year 1961, There is an item of proposed dividend of a like sum in respect of the year 1961. But this proposal did not arise before 15th March, 1968. Therefore, as on 1st January, 1962, it formed a part of unappropriated mass of profit of the current year. Consequently, this sum also cannot be considered as a reserve.

So far as the provision for gratuity is concerned, this is undoubtedly in the nature of a reserve. This provision is to meet contingent liabilities and not accrued liabilities. It is not allowed for income-tax purposes. The amount is withheld in the business to be utilised as and when any retirement gratuity is sanctioned. This payment could well have been met from out of general reserves. Consequently, we hold that the provision for retirement gratuity has to be treated as a reserve. As on 1st January, 1961, the balance stood at Rs. 5 lakhs and it was increased by a further sum of Rs. 2 lakhs only after 1st January, 1962. Consequently, the sum of Rs. 5 lakhs only should be treated as part of the reserves. So far as the provision for bonus is concerned it is again an appropriation for meeting a definite liability to be incurred at the end of the year. We, therefore, agree with the authorities below that this is not a reserve.'

8. On the aforesaid facts and the findings of the Tribunal the questions of law which we have earlier set out have been referred to this court.

9. We have to observe that in the instant case there is no dispute that the items claimed have not been allowed as a deduction in income-tax assessment. The only question is whether the said items can be said to constitute, reserves within the meaning of Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.

10. Mr. Bajoria, learned, counsel appearing on behalf of the assessee, has submitted before us that the word 'reserve' has not been defined in the Act and the said word must, therefore, be given its ordinary dictionary meaning. It is Mr. Bajoria's contention that this interpretation is clearly indicated by the decision of the Supreme Court in the case of Commissioner of Income-tax v. Century Spinning and . : [1953]24ITR499(Bom) . Relying on the said decision, Mr. Bajoria contends that the ordinary meaning of the word 'reserve' as given in the dictionary and as noted by the Supreme Court is ;

'(1) To keep for future use or enjoyment; to store up for some time or occasion ; to refrain from using or enjoying at once.

(2) To keep back or hold over to a later time or place or for further treatment.

(3) To set apart for some purpose or with some end in view ; to keep for some use.

(4) To retain or preserve for certain purposes,'

11. It is the contention of Mr. Bajoria that on the basis of the aforesaid meaning of the word reserve, the amounts in question clearly come within the meaning of the word 'reserve' as these are amounts set apart for future use or enjoyment and these are also amounts set apart for some purpose or with some end in view to keep for some use. Mr. Bajoria has contended that the same meaning has been given to the word 'reserve' by the Supreme Court in the case of Commissioner of Income-tax v. Standard Vacuum Oil Co. : [1966]59ITR685(SC) . Mr. Bajoria has also relied on the decision of this court in the case of Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax : [1958]33ITR579(Cal) . Relying on the aforesaid decisions Mr. Bajoria contends that in construing the word 'reserve' the ordinary dictionary meaning should be given to the said word and by giving the ordinary dictionary meaning to the expression 'reserve' these items should certainly be held to constitute 'reserve'. Mr. Bajoria has very fairly submitted that if the ordinary meaning is not given to the word 'reserve' but if the said word is construed with reference to the provisions in the company law or the principles of commercial accountancy, the items claimed in the instant case cannot be considered to be 'reserve' but they will in that case become 'provisions'. It is, however, Mr. Bajoria's contention that the Supreme Court has deliberately chosen not to give to the word 'reserve' the meaning in which it is understood in company law or in commercial accountancy but the Supreme Court has held that the said word should receive the ordinary dictionary meaning. Mr. Bajoria contends that in view of the said decision of the Supreme Court these items which may be otherwise considered to be provisions on the principles of commercial accountancy or under the provisions of theCompanies Act and they may be so understood by business, but for the purpose of this particular statute these items should constitute reserve and the assessee, on the said footing that these items constitute reserves, should be entitled to get the benefit of these items in the computation of its capital, Mr. Bajoria has also referred to the following decisions :

(1) Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC .--Mr. Bajoria has submitted that the observations of the Supreme Court as to the nature and character of reserve in the instant case were made on the basis of the provisions contained in the Payment of Bonus Act, 1965, and the said observations cannot be said to be observations of a general nature affecting the question of the meaning and interpretation of the word 'reserve ' in the instant case.

(2) Commissioner of Income-tax v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) .

(3) Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) . Mr. Bajoria has commented that in this decision the Allahabad High Court was concerned with an identical question and the Allahabad High. Court has held in favour of the assesses.

(4) Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) . Mr. Bajoria has criticised this decision of the Allahabad High Court on the ground that the same Bench of the Allahabad High Court took a different view in this case on the identical question without referring to its earlier decision.

(5) Commissioner of Income-tax v. Vasantha Mills Ltd. : [1957]32ITR237(Mad) . Mr. Bajoria has referred to Schedule VI to the Companies Act, 1956, and has drawn our attention to the form of the balance-sheet particularly to the item under the head 'Reserve and Surplus'. Mr. Bajoria has, however, argued that in view of the decisions of the Supreme Court in the case of Century Spinning and . : [1953]24ITR499(SC) and also in the case of Standard Vacuum Oil Co. : [1966]59ITR685(SC) , this court, in construing the word 'reserve', in so far as this Act is concerned should give the said word its ordinary dictionary meaning, and by giving to the word the ordinary dictionary meaning, this court should hold that these items claimed constitute reserves and should be considered to be reserves for the purpose of computation of the capital of the company under this particular Act. Mr. Bajoria has fairly pointed out that these items are to be treated as provisions and are not to be considered as reserves either under the provisions of the company law or on the basis of commercial accountancy and indeed the balance-sheet of the company will not indicate these items to be reserves of the company. It is the argument of Mr. Bajoria that though these items may properly be termed as provisions under the company law or under the principles ofcommercial accountancy, for this particular Act these items should be considered to bo reserves as the word 'reserve' has to be understood in its ordinary sense, giving to the word the dictionary meaning.

12. Mr. Suhas Sen, learned counsel appearing on behalf of the department, has contended that these items cannot be said to constitute reserves and these are really provisions for meeting existing or accrued liabilities. Mr. Sen has contended that so far as the second item, viz., 'proposed dividend' is concerned, that is clearly covered by the decision of the Supreme Court in the case of Century Spinning and . : [1953]24ITR499(SC) . Mr. Bajoria has fairly stated that in view of the decision of the Supreme Court in the said decision of Century Spinning and . : [1953]24ITR499(SC) , he cannot seriously contend that the said Hem should be treated as reserve as the facts of the instant case on this aspect also happen to be similar to the facts in the ease before the Supreme Court. Mr. Sen has contended that the Supreme Court has not laid down that any provision for payment of any existing or accrued liability could be considered to be a reserve. It is Mr. Sen's contention that even if ordinary meaning be given as stated by the Supreme Court, it does not mean that a provision for existing liability is to be considered to be a reserve even on the basis of the ordinary meaning. Mr. Sen has pointed out that even in the case of Century Spinning and . : [1958]33ITR579(Cal) , the Chief Justice considered the meaning of the expression as it is understood in company law and has also considered the question from various aspects. Mr. Sen contends that the decision of the Supreme Court in the case of Metal Box Company of India Ltd. v. Their Workmen : (1969)ILLJ785SC really concludes the question. It is the argument of Mr. Sen that though in the said case the Supreme Court was considering the provisions of the Payment of Bonus Act, 1965, but while considering the said Act the Supreme Court had occasion to consider the content and import of the word 'reserve' and the sense in which the same should be understood and the observations of the Supreme Court in the said case are of general nature and are not restricted to the provisions of the Payment of Bonus Act. Mr. Sen argues that a provision for payment of any existing liability cannot be considered to be a 'reserve' as that is indeed the making of a provision for a liability which has already accrued. It is the argument of Mr. Sen that there must at least be a clear indication of the intention on the part of the company to create a reserve and unless the said intention is clearly expressed by the authority competent and a 'reserve' as such is created, there cannot beany 'reserve' within the meaning of this particular Act. Mr. Sen argues that while making provisions for payment of any existing or accrued liability, the directors of the company do not intend to create a reserve and there is no indication or declaration of any intention and there cannot be any indication or declaration of any intention to create any reserve as such. Mr. Son has relied on the decision of the Supreme Court in the case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Weatth-tax : [1966]59ITR767(SC) . Relying on this decision Mr. Sen contends that liability for payment of tax is an accrued liability and is a debt owed by the Company. Mr. Sen has also drawn our attention to the decision of the Mysore High Court in the case of Mysore Electrical Industries Ltd. v. Commissioner of Surtax which has been included as an Appendix to the decision of the Supreme Court in the said case and is reported in : [1971]80ITR571(KAR) . Mr. Sen has also drawn our attention to the decision of the Bombay High Court in the case of Commissioner of Income-tax v. Aryodaya Ginning and . : [1957]31ITR145(Bom) . Mr. Sen has argued that in the earlier decision of the Allahabad High Court in Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) , the Allahabad High Court did not allow the question as to whether the provisions were being made for existing liabilities or not to be raised and in that view of the matter the Allahabad High Court held the said items to be 'reserves'. In the later decision of the Allahabad High Court in Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) , the Allahabad High Court considered this aspect and came to the conclusion that the provisions were being made for existing liabilities and in that view of the matter the Allahabad High Court held that those amounts could not be considered to be 'reserves'. Mr. Sen, therefore, submits that if any provision is made with regard to any existing liability such a provision cannot be considered to be a reserve within the meaning of this Act. It is the submission of Mr. Sen that in the instant case all those items are items making provision for existing liabilities and they, therefore, cannot be considered to be reserves.

13. In the case of Commissioner of Income-tax v. Century Spinning and. : [1953]24ITR499(SC) , the Supreme Court had occasion toconsider the meaning of the word 'reserve' while dealing with a case underthe Business Profits Tax Act (XXI of 1947). In that Act there was a similarprovision with regard to computation of the capital of the company andthe assessee had claimed that the amount recommended by the board ofdirectors and earmarked for payment of dividend to the shareholdersshould be treated as 'reserve' and should be taken into consideration assuch in computing the capital of the assessee. The Supreme Court observedat page 503 :

'The term 'reserve' is not defined in the Act and we must resort to the ordinary natural meaning as understood in common parlance. The dictionary meaning of the word ' reserve ' is :

'I (a) To keep for future use or enjoyment; to store up for some time or occasion; to refrain from using or enjoying at once.

(b) To keep back or hold over to a later time or place or for further treatment.

6. To set apart for some purpose or with some end in view ; to keep for some use.

II. To retain or preserve for certain purposes (Oxford Dictionary), vol. VIII, p. 513.'

14. In Webster's New International Dictionary, second edition, page 2118, 'reserve' is defined as follows :

' 1. To keep in store for future or special use ; to keep in reserve; to retain, to keep, as for oneself.

2. To keep back ; to retain or hold over to a future time or place.

3. To preserve '.'

15. The Supreme Court: then proceeded to hold at page 504 :

'What is the true nature and character of the disputed sum, must be determined with reference to the substance of the matter...... '

16. Taking into consideration the substance, the Supreme Court held that the recommendation of the directors for payment of the sum as dividend and earmarking the same for distribution as dividend did not make it a reserve and the amount remained as a mass of undistributed profits which were available for distribution and not earmarked as 'reserve'. The Supreme Court further observed (page 504) :

'The reserve may be a general reserve or a specific reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits on the 1st January, 1946, cannot automatically make it a reserve.'

17. The Supreme Court held at the same page :

'A reserve in the sense in which it is used in Rule 2 can only mean profit earned by a company and not distributed as dividend to the shareholders but kept back by the directors for any purpose to which it may be put in future.'

18. The Supreme Court also referred to the provisions of the Companies Act while considering the true nature and character of the amount and the Supreme Court observed at page 505 :

'Reference was made to Sections 131(a) and 132 of the Indian Companies Act. Section 131(a) enjoins upon the directors to attach to every balance-sheet a report with respect to the state of the company's affairs andthe amount if any which they recommend to be paid by way of dividend and the amount, if any, which they propose to carry to the reserve fund, general reserve or reserve account. The latter section refers to the contents of the balance-sheet which is to be drawn up in the Form marked ' F * in Schedule III. This Form contains a separate head of reserves. Regulation 99 of the First Schedule, Table A, lays down that the directors may, before recommending any dividend, set aside out of the profits of the company such sums as they think proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for meeting contingencies, or for equalising dividends, or for any other purpose to which the profits of the company may be properly applied......The regulationsuggests that any sum out of the profits of the company which is to be made as a reserve or reserves must be set aside before the directors recommend any dividend. In this case the directors while recommending dividend took no action to set aside any portion of this sum as a reserve or reserves. Indeed, they never applied their mind to this aspect of the matter. The balance-sheet drawn up by the assessee as showing the profits was prepared in accordance with the provisions of the Indian Companies Act. These provisions also support the conclusion as to what is the true nature of a reserve shown in a balance-sheet.'

19. In the case of Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax : [1958]33ITR579(Cal) , this court had occasion to consider whether an advance payment made by a company under Section 18A of the Income-tax Act, could be treated as part of its 'reserves' for the purpose of computing the capital of the company under Schedule II of the Business Profits Tax Act, 1947, and in dealing with the question this court had occasion to consider the meaning and import of the word 'reserve'. This court has held that the reserve is by its very nature a fund which is created and maintained for the purpose of being drawn upon in future, and nothing can be reserved unless it has been reserved or laid by or stored for use or application in a future contingency which is anticipated as certain or likely and payments which are made in discharge of a present liability in the course of the year to which the balance-sheet and profit and loss account relate cannot be said to be made by way of creating a reserve. Chakravartti C.J., who delivered the judgment of the Bench, observed at page 584 :

'The general question, therefore, is whether it can be said that when a company makes advance payments of tax under Section 18A of the Income-tax Act, it creates a reserve as the term is understood in company law. In the case of Commissioner of Income-tax v. Century Spinning and . : [1953]24ITR499(SC) , the Supreme Court had occasion to point out how and when reserves were created. They observed that someone possessed of the requisite authority must make a declaration orgive some indication that the manner of the disposal of or the destination of the amount in question is that it is being carried to reserve. That was looking at the question of the creation of a reserve from the procedural point of view. We are concerned in this case with the nature of a reserve. If I may refer to the definition given in Murray's Oxford Dictionary to which the Supreme Court also referred, but only to give the various meanings of the word 'reserve' as a verb, the meaning as a noun is given as follows :

'Something stored up, kept back, or relied upon, for future use or advantage; a store or stock.'

An illustration of such use of the word 'reserve' is drawn from Political Economy by Rogers and the following sentence is quoted :

'It is a maxim in business that a man......should have a hoard orreserve from which he can draw, when the times are untoward.'

Apart from the dictionary meaning of the word 'reserve' I think it can hardly be disputed that nothing can be reserved unless it has been reserved or laid by or stored for use or application in a future contingency which is anticipated as certain or likely. In the actual administration of companies also a part of the surplus profits is removed from the immediate business of the company by way of a provision against future contingencies and a reserve is thus created, although after being carried to the reserve, the amount in question may be invested or re-employed in the business, if the articles so permit.'

20. The learned Chief Justice has further observed at page 588 :

'The next consideration which appears to me to be relevant is also fundamental. A reserve as I have endeavoured to explain is by its very nature a fund which is created and maintained for the purpose of being drawn upon in future. If certain payments are to be made in discharge of a present liability in the course of the year to which the balance-sheet and the profit and loss account relate, I am unable to see how such payments can be said to be made by way of creating a reserve. They are clearly of the nature of expenditure, although it may not be expenditure in the income-tax sense allowable in an assessment, but none the less they are expenses incurred and met by the company in the course of its business existence during the year when liabilities requiring an instant discharge arise. A reserve is created only out of the whole or a part of the surplus profits as they are found to be in the hands of the company at the end of the year and it is a reserve against a contingency which still lies in the future. Payments under Section 18A do not, in my view, satisfy that test. Their true nature is that they are payments on account, made under the compulsion of a statute, towards the discharge of an instant liability for liquidating a charge, the precise measure of which is to be determined at a later date.'

21. In the case of Commissioner of Income-tax v. Standard Vacuum Oil Co. : [1966]59ITR685(SC) , the Supreme Court had occasion to consider the meaning and import of the word 'reserve' while dealing with the case, which was under the Business Profits Tax Act, 1947. The Supreme Court at page 694 held that the observations of Chagla C.J. in Century Spinning & Manufacturing Co.'s case [1951] 20 ITR 260, to the effect that a reserve in the sense in which it is used in Rule 2 can only mean profit earned by a company and not distributed as dividends to the shareholders but kept back by the directors for any purpose to which it may be put in future, were only made in reference to the facts of the case and were not intended to lay down that reserves built up from sources other than profits would not be admissible for inclusion in capital under Rule 2(1) of the Business Profits Tax Act. The Supreme Court observed at page 698 :

'In its ordinary meaning the expression ' reserve ' means something specifically kept apart for future use or for a specific occasion.'

22. In the case of Commissioner of Income-tax v. Vasantha Mills Ltd. : [1957]32ITR237(Mad) , the Madras High Court had occasion to consider whether an allocation of two sums for payment of income-tax and excess profits tax by the directors can be claimed to constitute reserve within the meaning of the Business Profits Tax Act, 1947, in computing the capital of the company. In the balance-sheet of the assessee-company for the calendar year 1945, a sum of Rs. 2 lakhs was shown as reserve for the payment of income-tax and excess profits tax. This allocation was made by a resolution of the board of directors at a meeting held on 15th March, 1946, and the shareholders' meeting to consider the directors' report was held on 15th April, 1946. The articles of association of the company gave absolute discretion to the directors to allocate sums of money to the reserves before they recommended a dividend. For the chargeable accounting period April 1, 1946, to 31st December, 1946, the assessee-company claimed that in computing its capital for the purposes of abatement under Rule 2(1) of Schedule II to the Business Profits Tax Act, these two sums should be included in the reserves. The Madras High Court, in the facts and circumstances of the case, held that there was a valid and effective allocation of the two sums to the reserves before the material date, namely, 1st April, 1946, and the allocation of the sum of Rs. 9 lakhs to be set apart for utilisation towards the payment of tax was a 'reserve' within the meaning of Rule 2(1). The Madras High Court at pages 251-252 observed ;

'As pointed out by the Supreme Court in Commissioner of Income-tax v. Century Spinning and . : [1953]24ITR499(SC) , 'the term 'reserve' is not defined in the Act and we must resort to the ordinary natural meaning as understood in common parlance'. Their Lordships then set out the dictionary meaning of the word 'reserve'.One such meaning was 'To set apart for some purpose or with some end in view, to keep for some use'. If that meaning were to prevail, it should be obvious that the sum of Rs. 9,00,000 was set apart for a specified purpose with a specified end in view, payment of taxes when they fell due. Reservation of a specified sum for a specified use, when the reservation has been validly made by a person having authority to do so, would appear to bring the sum so reserved within the meaning of the expression 'reserve' in Rule 2(1). We should, however, make it clear that we are concerned in this case only with the question, whether the allocation of a specified sum out of the profits of the company to be kept back for utilisation towards the payment of tax is sufficient to make the sum so set apart a reserve within the meaning of Rule 2(1). We are not concerned with any of the other purposes for which the directors could have set apart a specified sum.'

23. It may be noted that this decision of the Madras High Court came up for consideration before the Supreme Court in the case of Commissioner of Income-tax v. Mysore Electrical Industries Ltd. : [1971]80ITR566(SC) . The Supreme Court observed at page 570 :

'The learned Solicitor-General referred to a judgment of the Madras High Court in Commissioner of Income-tax v. Vasantha Mitts Ltd. : [1957]32ITR237(Mad) , where the Madras High Court dissented from the view expressed by the Bombay High Court on the ground that there could be no reserve until there was allocation in fact by a person having the requisite authority to order that allocation. In our view, although such allocation was factually not possible on the very first 'day of a year but allocation on a later day should be treated as effective from that day in view of the fact that the division of undistributed profits became effective from that day.'

24. In the case of Metal Box Company of India Ltd. v. Their Workmen [1963] 73 ITR 53, the Supreme Court, while dealing with a case under the Payment of Bonus Act, 1965, had occasion to consider the expression 'reserve' and its meaning. The Supreme Court observed at pages 67-68 :

'The next question is whether the amount so provided is a provision or a reserve. The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest (see Spicerand Pegler's Book Keeping and Accounts, 15th edition, page 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision 3 (See William Pickles' Accountancy, second edition, page 192; Part III, Clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve).'

25. In the case of Commissioner of Income-tax v. Security Printers of India (P.) Ltd. : [1972]86ITR210(All) , the Allahabad High Court had to consider a case very similar to the one before us. In that case, while considering the meaning of the word 'reserve' in Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, the Allahabad High Court held that the provisions for bonus, the provisions for taxation and the provisions for proposed dividend by a company are entitled to be treated as 'reserves' for the purpose of Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, and they should be included in the computation of capital under that provision where there was no dispute that the three items had actually been debited to the assessee's profit and loss account and had not been allowed as a deduction for the purpose of income-tax assessment. The Allahabad High Court in its judgment referred to various decisions including the decision of the Supreme Court in the case of Commissioner of Income tax v. Century Spinning & . : [1953]24ITR499(SC) , the decision of the Supreme Court in the case of Commissioner of Income-tax v. Standard Vacuum Oil Co. : [1966]59ITR685(SC) and the decision of this court in the case of Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax : [1958]33ITR579(Cal) , which we have earlier noted. After referring to various decisions, the Allahabad High Court observed at page 215 :

'From the cases referred to, one thing is clear. And that is that the term 'reserve' means a sum specifically kept apart for future use or for a specific occasion. The reservation must be effected by someone having authority to do so, and it must be of a specified sum for a specified use. Where it arises out of tbe surplus profits of the company, it should be set apart before the distribution of dividends to the shareholders. It is a sum laid by or stored for use or application in a future contingency which is anticipated, a fund which is created and maintained for the purpose of being drawn upon in future.'

26. The Allahabad High Court then proceeded to observe :

'Upon the facts before us it is clear that the three items, provision for bonus, for taxation and for proposed dividends represent amounts specifi-cally set apart for meeting future liabilities. It does not appear that the revenue ever contended before the Tribunal that the amounts represent liabilities which had already arisen during the relevant previous year and were not intended for a future contingency. Nor was it questioned that the provision was made by the requisite authority. An attempt has been made before us on behalf of the revenue to raise those questions, but we are unable to permit those points to be raised as they were not raised before the Tribunal. There is no dispute that the three items have actually been debited to the assessee's profit and loss account and that they have not been allowed as a deduction for the purposes of income-tax assessment.'

27. In the case of Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) , the same Bench of the Allahabad High Court had occasion to consider a more or less similar question under the same Act, namely, the Super Profits Tax Act, 1963, the Act with which we are concerned in the present reference. In this case, before the Allahabad High Court in the assessment proceedings under the Super Profits Tax Act, 1963, for the assessment year 1963-64, the assessee-company claimed the inclusion of the following four items in the computation of capital: (1) proposed dividends, Rs. 4,17,500 ; (2) provision for taxation, Rs. 19,15,028 :(3) credit balance of profit and loss account, Rs. 12,679; and (4) depreciation reserve being excess of book depreciation over income-tax allowed depreciation, Rs. 2,23,185. The Allahabad High Court held that the said four items did not represent 'reserves' and could not be included in the computation of capital under the Super Profits Tax Act, 1963, and that to constitute a 'reserve' the amount must be specifically kept apart for future use or for a specific occasion. In this case also, the Allahabad High Court referred to the decision of the Supreme Court in the cases of Commissioner of Income-tax v. Century Spinning & . : [1953]24ITR499(SC) , Commissioner of Income-tax v. Standard Vacuum Oil Co. Ltd. : [1966]59ITR685(SC) and of the Calcutta High Court in Indian Steel & Wire Products Ltd. v. Commissioner of Income-tax : [1955]27ITR436(Cal) and also other decisions.

28. After considering the various decisions, the Allahabad High Court held at pages 492-493 :

'Turning to the facts before us, it seems that the item of Rs. 4,17,500 representing proposed dividends cannot be treated as a reserve. It appears that the board of directors of the assessee made a proposal to the shareholders that the amount be distributed among the shareholders by way of dividends and made a provision, for that amount in the balance-sheet of the year ending December 31, 1961. Apparently, therefore, the amount was earmarked for payment of dividend and was not treated by the directors as a reserve. So far as this item is concerned, the case, in our opinion, falls within the rule laid down in Century Spinning & .'s case : [1953]24ITR499(SC) . It remained a mass of undistributed profits liable to be distributed as dividend upon the acceptance of the recom-mendation by the shareholders. It was not set apart as a reserve for any purpose, and, therefore, could not be treated on 1st January, 1962, the first day of the relevant previous year, as a reserve for the purpose of Schedule II, Rule 1, of the Super Profits Tax Act. Reference may be made to regulation 87 of Table A of the First Schedule to the Companies Act, 1956.

29. The next item is Rs. 19,16,028 shown as provision for taxation. This consists of Rs. 12,41,028 representing the provision for taxation during the preceding accounting year and Rs. 6,75,000 representing the provision made during the year. From the contention made on behalf of the assessee before the Tribunal, one gathers that the provision was made for taxation in anticipation of quantification of the tax liability. It was a provision and not a reserve. It was provision made for current liability, the liability having already accrued when the income was earned and awaited merely quantification by assessment. It was not a reserve because it was designed to meet a liability known to exist on the date of the balance-sheet. Consequently, in our opinion, the item representing provision for taxation cannot also be treated as a reserve for the purpose of the Super Profits Tax Act.'

30. The Bench further observed at pages 493-494 :

'It is urged on behalf of the assessee that case law relating to the Business Profits Tax Act is not relevant for the purpose of deciding the question under the Super Profits Tax Act. The Business Profits Tax Act, it is pointed out, was passed when the Indian Companies Act, 1913, was still in force, and the position has since changed by the enactment of the Companies Act, 1956. It is urged that, therefore, the law laid down by the Supreme Court in Century Spinning & .'s case : [1953]24ITR499(SC) cannot be applied. We are unable to see how the position has changed. In Century Spinning & 's case : [1953]24ITR499(SC) , the Supreme Court relied upon regulation 99 of Table A of the First Schedule of the Indian Companies Act, 1913, which provided that before recommending any dividend the directors may set aside out of the profits of the company such sums as they thought proper as a reserve. It was emphasised that according to the regulation any sum out of the profits of the company which was to be made a reserve has to be set aside before the directors recommended any dividend. It is apparent from the corresponding regulation 87 of the Table 'A' of the First Schedule to the Companies Act, 1956, that the position remains materially the same.

31. It seems to us that if we refer to the Companies Act, 1956, the position which emerges is in no way inconsistent with what has been laid downby the Supreme Court in the cases mentioned above. Section 211 of the Act provides that the balance-sheet of a company shall be in the form set out in Part I of Schedule VI. In the form of balance-sheet set out in Part I of Schedule VI, item II is headed 'Reserve and Surplus'. Clause (5) of item II reads :

'Surplus, that is balance in profit and loss account after providing for proposed allocations, viz., dividend, bonus or reserves.

32. The balance in the profit and loss account is referred to as the 'Surplus', and, as the head 'Reserve and Surplus' clearly indicates, a surplus is not a reserve. Therefore, the balance in the profit and loss account cannot be treated as a reserve. Then, in the same clause a proposed allocation for dividend is spoken of as distinct from allocation for reserve, thus showing that the one cannot be comprehended within the other. On the contrary, item V headed 'Current Liabilities and Provisions' refers by Clause (8) to 'proposed dividends '. Apart from proposed dividends, we may point out that item V also contains Clause (6) which refers to ' Provision for Taxation'. That has not been classified in item II which is headed 'Reserve and Surplus', thus showing that provision for taxation is not to be treated as a reserve. What is a reserve for the purposes of Part I of the Schedule has been defined by Clause 7(1)(b) of Part III of Schedule VI. The definition reads:

'7. (1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires,--......

(b) the expression 'reserve' shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability.'

33. Applying this interpretation clause, it is evident that the provision for taxation before us must be excluded from the expression 'reserve '.' In the instant case, the proposed dividend cannot be treated as a reserve as the amount remains a mass of undistributed profits of the company and, therefore, cannot be considered to constitute any reserve. This aspect, in our opinion, is clearly covered by the decision of the Supreme Court in the case of Commissioner of Income-tax v. Century Spinning & . : [1953]24ITR499(SC) . So far as the other two items are concerned, namely, provision for taxation and provision for bonus, in our view the said items cannot also be considered to constitute reserves as the said items are really provisions for payment of an existing liability. On this aspect we are in agreement with the view expressed by the Allahabad High Court in Commissioner of Income-tax v. Hind Lamps Ltd. : [1973]90ITR487(All) . We may also note that while this provision was made no action was taken to set apart these sums or any portion thereofas a 'reserve' or 'reserves'. The balance-sheet drawn up by the asses-see as showing the profits was prepared in accordance with the provisions of the Companies Act and they do not indicate that these items were allocated to any reserve. These items were items providing for payments of existing liabilities and any provision made for meeting an existing liability cannot, in our opinion, constitute 'reserve'.

34. An amount provided for meeting an accrued and existing liability cannot be said to have been set apart for meeting a contingency which may arise in future and cannot, therefore, constitute reserve. It is, indeed, a provision for meeting an existing liability and not a reserve for any future contingency.

35. The question No. 2, therefore, has to be answered in the affirmative, in favour of the revenue and against the assessee and the said question is answered accordingly.

36. There will be no order as to costs.

Hazra, J.

37. I agree.


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