1995 (12) TMI 22 - HC - Income Tax

Summary

Issues Involved:
1. Whether the debenture redemption reserve created by the assessee is a "provision to meet a known liability" or a "reserve" to be included in capital computation under the Companies (Profits) Surtax Act, 1964.

Detailed Analysis:

Issue 1: Nature of Debenture Redemption Reserve
The primary issue revolves around the classification of the debenture redemption reserve as either a "provision" or a "reserve." The assessee-company had issued 35,000 debentures of Rs. 100 each, amounting to Rs. 35,00,000. A debenture trust deed dated December 28, 1970, mandated the creation of a debenture redemption reserve, which had accumulated to Rs. 15,00,000 by the relevant assessment year.

The Income-tax Officer and the Commissioner of Income-tax (Appeals) classified this reserve as a provision for a known liability, thus excluding it from the capital base. However, the Appellate Tribunal, referencing clause 20 of the debenture trust deed, concluded that the reserve should be treated as a "reserve" for capital computation purposes because the assessee was allowed to utilize the amount for business purposes until the actual redemption of the debentures.

Arguments by the Department
The Department argued that the debenture redemption reserve is essentially a provision to meet a known liability, citing the Supreme Court's decision in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53. They contended that the ability to use the reserve before redemption does not alter its fundamental nature as a provision for a known liability.

Arguments by the Assessee
The assessee countered that the Explanation to rule 1 of the Second Schedule does not apply to the debenture redemption reserve. They pointed out that the reserve does not fall under items (5), (6), or (7) of the "Reserves and surplus" heading in the balance-sheet format under Schedule VI of the Companies Act, 1956. They emphasized that the debenture redemption reserve was not converted into a fund with corresponding assets in the balance-sheet, reinforcing its nature as a reserve.

Judicial Precedents
Several judicial precedents were considered:

1. Bombay High Court in CIT v. National Rayon Corporation Ltd. [1986] 160 ITR 716: Held that the debenture redemption reserve was a provision for a known liability and not includible in the capital base.
2. Supreme Court in CIT v. Elgin Mills Ltd. [1986] 161 ITR 733: Distinguished between "provision" and "reserve," stating that a provision is a charge on profits, while a reserve is an appropriation of profits.
3. Delhi High Court in CIT v. Modi Industries Ltd. (No. 2) [1992] 197 ITR 655: Held that a debenture redemption fund created by appropriating profits was a reserve and includible in the capital base.
4. Calcutta High Court in CIT v. Peico Electronics and Electricals [1987] 166 ITR 299: Concluded that the debenture redemption reserve was a reserve because it was created from profits, retained as part of the capital employed, and the liability was a future one.

Conclusion
The court analyzed the distinction between a provision and a reserve, emphasizing that a provision is a charge against profits, while a reserve is an appropriation of profits retained as part of the capital employed in the business. The crucial factor was the right of the company to use the debenture redemption reserve for business purposes until the redemption date, indicating that it was not set apart solely to meet a known liability.

The court held that the debenture redemption reserve in this case was a reserve and not a provision, thereby includible in the capital base. The judgment affirmed the Tribunal's decision and answered the question in the affirmative, against the Department. No costs were awarded.