1992 (7) TMI 29 - HC - Income Tax

Summary

Issues Involved:

1. Whether the amounts provided by the assessee for bad and doubtful debts in the balance-sheets of the relevant previous years qualified as reserves for the purpose of clause (xi)(b) of rule 1 of the First Schedule to the Companies (Profits) Surtax Act, 1964.
2. Whether the amounts provided for bad and doubtful debts as at the beginning of the relevant accounting year for the assessment years 1971-72, 1972-73, 1973-74, and 1975-76 qualified as a reserve for inclusion in the capital of the assessee under the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Detailed Analysis:

Issue 1: Qualification of Amounts as Reserves under Clause (xi)(b) of Rule 1 of the First Schedule

The core point requiring determination is whether the amounts set apart by the assessee for bad and doubtful debts in the balance-sheets constitute a "reserve" as per rule 1(xi)(b) of the First Schedule to the Companies (Profits) Surtax Act, 1964. The 1964 Act imposes a special tax on the profits of certain companies, and the term "chargeable profits" is defined under section 2(5) of the Act. The assessee, a banking company, claimed deductions for amounts set apart for bad and doubtful debts, arguing these were "reserves" within the meaning of clause (xi)(b) of rule 1 of the First Schedule.

The Surtax Officer and the Appellate Assistant Commissioner of Surtax, Patiala, disagreed, classifying these amounts as "provisions" rather than "reserves." The Tribunal, however, accepted the assessee's contention, noting that the amounts were shown as "reserves" in unpublished balance-sheets, even though they appeared as "provisions" in the published balance-sheets. The Tribunal's decision was based on the practice of banking companies maintaining unpublished balance-sheets, as recognized under section 34A of the Banking Regulation Act, 1949.

Issue 2: Qualification of Amounts as Reserves for Inclusion in Capital under the Second Schedule

The second issue pertains to whether the amounts set apart for bad and doubtful debts qualify as reserves for inclusion in the capital of the assessee under rule 1(iii) of the Second Schedule to the 1964 Act. The Tribunal, referring to a similar case involving Punjab State Small Industries Corporation Ltd., held that the amounts should be treated as "reserves." However, the Revenue contended that these amounts were "provisions" and not "reserves."

The Supreme Court's distinction between "provisions" and "reserves" in Metal Box Co. of India Ltd. v. Their Workmen and subsequent cases was pivotal. Provisions are charges against profits for anticipated liabilities, whereas reserves are appropriations of profits. The Tribunal's reliance on unpublished balance-sheets and the practice of maintaining secret reserves was also examined. The Supreme Court in All India Bank Employees' Association v. National Industrial Tribunal recognized the practice of banking companies maintaining secret reserves.

Conclusion:

The court concluded that the amounts set apart by the assessee for bad and doubtful debts were "provisions" and not "reserves." The distinction between a "provision" and a "reserve" is well-established in commercial accountancy and judicial precedents. Provisions are for anticipated liabilities, while reserves are appropriations of profits. The intent of the board of directors, who described the amounts as "provisions" in published balance-sheets, was also considered.

The Tribunal erred in law by treating these amounts as "reserves." The court answered both questions in the negative, against the assessee and in favor of the Revenue. The reference was answered accordingly, with parties bearing their own costs.