TMI Blog1993 (12) TMI 116X X X X Extracts X X X X X X X X Extracts X X X X ..... These common questions have arisen for consideration in a number of other cases, which were all heard together. 4. For the reasons detailed in the Annexure to this order, which may be read as part of this order, we decide both the questions in favour of the assessee. We further direct the Assessing Officer to modify the surtax assessments accordingly. Issue No. 2- Investment Allowance Reserve Rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 5. This issue is common to the asst. yrs. 1983-84 and 1984-85. 6. Even while taking into account the investment allowance created by the assessee for purposes of computing the capital base of the assessee-company for the purposes of surtax, the Assessing Officer, purporting to invoke the provisions of r. 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, carried out an adjustment in relation to the investment allowance actually allowed to the assessee. In the process, he reduced the capital base pro tanto. 7. On his part, the CIT(A) declined to interfere in the matter. 8. On hearing both the sides, we are of the opinion that the assessee is entitled to succeed. 9. The IT Act imposes a cha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Assessing Officer misdirected himself in law when he thought that he could invoke the provisions of r. 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 for making the impugned adjustment. 13. In this connection, it may be highlighted that it was on the basis of the aforesaid consideration that Courts [including the Madras High Court See Addl. CIT vs. Bimetal Bearings Ltd. 1978 CTR (Mad) 50 : (1977) 110 ITR 131 (Mad)] have held that deductions allowed under Chapter VI-A of the Act cannot be subject-matter of the adjustments contemplated by r. 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. 14. In view of the foregoing, therefore, we set aside the impugned orders of the lower authorities on this issue and direct the Assessing Officer to compute the capital base by leaving out of reckoning the investment allowance granted to the assessee. 15. In the result, the appeals are allowed. ANNEXURE Interpretation of r. 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964 The basic question here is whether the excess of the amount allowed as and by way of depreciation allowance in income-tax assessment over the amou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as not urged before the Supreme Court". In that case, the High Court has referred to the Supreme Court case of Somawanti vs. State of Punjab 33 Comp. Cas. 745 in which it had been held: "...The binding effect of a decision does not depend upon whether a particular argument was considered therein or not, provided that the point with reference to which an argument was subsequently advanced was actually decided." 4. On his part, Shri Ramamani, the learned counsel for the assessee, contended first that in Zenith Ltd., the Supreme Court affirmed the decision of the Bombay High Court in Zenith Steel Pipes Ltd. and dismissed the appeals filed by the said Bombay assessee not on an examination of the merits of the case, but in view of the statement of the counsel that the issues were covered against the appellant by one or other of the pronouncements of the Supreme Court. According to him, in the context of the statement of the counsel, the Supreme Court did not have any occasion to decide the legal questions after hearing both the sides. Secondly, in the cases before us, he would be raising contentions which were not raised before the Bombay High Court contentions that have a direct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ave also shrunk in size pro tanto. Rule 1(iii) talks of other reserves being reduced by the amount credited to such reserves as have been allowed as a deduction in computing the income of the assessee-company for the purposes of the IT Act. The term 'other reserves' encompasses general reserve also. By reason of the assessees' charging to profits a lesser sum as and by way of depreciation, the differential went to augment the general reserve. In the income-tax assessments, however, deduction had been allowed in respect of the differential. Therefore, the general reserve needs to be reduced pro tanto by virtue of the provisions of r. 1(iii). The same consideration will apply, with equal force, to the aggregate differential. 7. In this regard, the Assessing Officer referred to and relied upon the Bombay case of Zenith Steel Pipes Ltd. And the first appellate authority declined to interfere in the matter. 8. Shri Ramamani, the learned counsel, who appeared on behalf of most of the assessees, strongly contended that the lower authorities were not justified in interpreting the provisions of r. 1(iii) the way they had done. Drawing our attention first to the provisions of r. 1(iii), ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount credited to such reserves is allowed as a deduction to the extent specified in the IT Act. According to Shri Ramamani, it is such types of reserve that are hit by r. 1(iii) of the Second Schedule to the Companies (Profits) Surtax Act. There is no statutory warrant to travel beyond the aforesaid three types of reserves. 10. Shri Ramamani then highlighted the fact that in the Bombay case of Zenith Steel Pipes Ltd., there is no discussion on the aforesaid aspects of the case. As for the Supreme Court decision in Zenith Ltd., these aspects could not be examined, because the appeals were dismissed after placing on record the submissions of the counsel. 11. The next limb of Shri Ramamani's argument was that it is not the scheme of the Surtax Act that the Assessing Officer should be permitted to break the balance sheet of the assessee-company and to make inroads into it in the guise of making adjustments not specifically contemplated by the Companies (Profits) Surtax Act. 12. In view of the foregoing, therefore, contended Shri Ramamani, on a proper interpretation of the provisions of r. 1(iii) of the Second Schedule, there is no warrant to reduce the capital base of the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ting that the aggregate differential went to augment the general reserves, as long as the amount capitalised out of the general reserve is more than the amount represented by the aggregate differential, the Department cannot insist on tracing the aggregate differential to general reserve alone. The assessee has the right to attribute the aggregate differential to the amount capitalised. Again, in the past, current year's lossses might have been written off to the reserves. In such circumstances also the assessee has a right to attribute the aggregate differential to the losses written off. Or again, in the past, a part of the general reserve might well have been utilised to declare dividends. In such cases also, the assessee could attribute such payments to the aggregate differential. According to Shri Mani, therefore, any attempt to bring within the pale of r. 1(iii) the aggregate differential is to oversimplify the matter. 17. In view of the foregoing, therefore, contended the learned counsel, the assessees are entitled to succeed on this issue. 18. On his part, Shri Raghavan, the learned Departmental Representative, strongly supported the impugned orders of the lower a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (SC) 186 : (1981) 132 ITR 559 (SC), excess provision is a reserve. That being so, there could possibly be no objection to hold that short provision of depreciation should go to reduce pro tanto the other reserves. 23. In his reply, Shri Ramamani summarised his arguments in the form of the following propositions and contended that the assessees were entitled to succeed. 1. The Second Schedule to the Surtax Act prescribes the method for computation of capital. The capital consists of paid up capital, stated reserves and other reserves. Rule 1(iii) of Second Schedule of the Surtax Act deals with other reserves. 2. Broadly speaking, what it provided is that a reserve cannot be created out of amounts allowed as a deduction for income-tax. There is an apparent contradiction in the sense that a reserve cannot be allowed as a deduction (as contrasted to a provision). But there are certain specific reserves which are allowed as a deduction for tax purposes. There are also items of capital expenditure allowed as a deduction [35AB, 35D, 35, etc.]. 3. In the context of depreciation, it is over-simplification to say that excess of income-tax depreciation over the book depreciation, i.e. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deduction is merely an arithmetical exercise because, by definition, statutory deduction means an amount equal to 15% of the capital base. 27. One thing will be clear from the foregoing and that is that if the capital base is increased inflated, if you like the statutory deduction will get increased or inflated pro tanto, and the surtax levied will in the process get reduced. The paid up share capital of the company, which is one of the components of the capital base being fixed, does not afford any scope for manoeuvering. Reserves, on the contrary, afford large scope for manoeuvering. For more than one reason. Firstly, the Companies (Profits) Surtax Act does not contain any definition of the term "Reserve". Secondly, even the Companies Act, 1956 contains a negative definition of the said term. Thirdly, there is the anxiety of the taxpayer to enlarge the capital base by bringing under its pale as many items as possible under the head 'Reserves'. Fourthly, the question whether a particular sum set apart by the company is a 'provision' or a 'reserve' was a bone of contention till the Supreme Court handed down its decision in the case of Vazir Sultan Tobacco Co. Ltd. vs. CIT. 28. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Surplus" in Part I "Form of balance sheet" of Schedule VI of the Companies Act, 1956, shall not be regarded as reserves for purposes of computation of capital of the company under the provision of the Second Schedule to the Surtax Act. 32. We may at this stage notice the loading case of Vazir Sultan Tobacco Co. Ltd. in which the Supreme Court has enunciated the following principles: Provision Provision is a retention or appropriation of a sum designed to meet depreciation, renewals or diminution in value of assets, or any known liability. Excess provision over the sum actually required is, however, a reserve. This is by operation of law [cl. 7 of Part III of Schedule VI of the Companies Act, 1956]. Reserve The Companies Act, 1956 gives a negative definition of "reserve". If any retention or appropriation of a sum falls within the definition of 'provision' it can never be a reserve; but it does not follow that if the retention or appropriation is not a provision, it is automatically a reserve. In such cases, the true nature and character of the sum will have to be decided with reference to the substance of the matter. A mass of undistributed profits cannot automatically b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rule? They are: (a) There should be reserves other than those covered by r. 1(ii); (b) Certain amounts should have been credited to such reserves, and (c) The amounts credited to such reserves must have been allowed as a deduction in computing the income of the assessee-company for the purposes of IT Act, 1922 or the IT Act, 1961. 35. The first criterion is that there should be other reserves. This would mean, in the phraseology of the Supreme Court, that somebody possessing the requisite authority (namely, the Board of Directors of the company) should have clearly indicated that a portion of the mass of undistributed profits of the company had been earmarked with a view to constituting a general or specific reserve. The second condition is that certain amounts should have been credited to the reserve. Here again, such crediting of amounts to the reserve should be a conscious, overt act of the authority competent to credit such sums to the reserve. The third pre-requisite is that the amount credited to the 'other reserves' must have been allowed as a deduction in computing the income of the company under the IT Act, 1922/IT Act, 1961. 36. What struck us immediately on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ost of assets. The general practice of accounting for depreciation is based on the said principle. Even so, it is not unusual for companies to credit the depreciation charged to profits to depreciation reserve account, leaving in tact the historical cost of the assets. In such cases, to the extent depreciation had been charged to profits, the historical cost of assets shown on the assets side of the balance sheet would be balanced by the amounts standing to the credit of depreciation reserve. In the assessment to income-tax, however, depreciation would be allowed as a deduction. In such circumstances, all the ingredients of r. 1(iii) are satisfied. There is the depreciation reserve. There are the amounts credited to the said reserve. And the amounts so credited are allowed as deduction for purposes of assessment to income-tax under the IT Act, 1922/IT Act, 1961. 40. Yet another situation could well be envisaged. Suppose there is a liability in praesenti in respect of which, normally, that assessee should have made a provision proper. Suppose further the assessee, instead of making a provision therefor, sets apart the required sum as and by way of a reserve; and yet successfully ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... two conditions are not satisfied. Therefore, as we see it, on a proper interpretation of r. 1(iii) of the Second Schedule of the Companies (Profits) Surtax Act, there is no call to reduce the capital base by the differential. In this connection, we may highlight the fact that the creation of a reserve represents a conscious, overt act on the part of the board of directors which possesses the accredited authority to create such reserves. It should, therefore, follow that, in cases of the type under consideration, the subsequent event, namely, the granting of depreciation allowance in a higher sum for purposes of income-tax assessment cannot be called to aid by the Department in support of the proposition that to the extent of the differential, a reserve has been created. 45. There is yet another aspect of the matter that is noteworthy. As pointed out earlier, the Surtax Act itself contains built-in provisions to ensure that the capital base does not get artificially inflated. Thus, r. 1A of the Second Schedule is designed to bring the axe down in all cases where no provision is made in the balance sheet either towards taxation or towards proposed dividends. It also applies to ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to be provided in relation to the book profits as reduced by the depreciation differential. The excess provision for taxation occasioned by the adjustment of the book profits to the extent of the depreciation differential will have to be treated as reserve. This is by operation of law See cl. 7 of Part III of Schedule VI of the Companies Act, 1956. This would mean that if at all any downward reduction of the capital base is warranted, the extent of the downward reduction could only be the difference between the depreciation differential on the one hand, and the excess provision for taxation on the other. 47. This brings us on to the question whether it is the intention of the Parliament that the balance sheet of the assessee-company should be subjected to such extensive changes amounting to mutilation. The learned counsel for the assessee, it may be recalled, contended, inter alia, that under the scheme of the Act, there was no warrant to break the balance sheet, to make inroads into it, except to the extent stipulated by and under the Act. We agree. As we see it, the scheme of the Act is to take the balance sheet as the starting point and to make only those adjustments there ..... X X X X Extracts X X X X X X X X Extracts X X X X
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