TMI Blog1972 (9) TMI 44X X X X Extracts X X X X X X X X Extracts X X X X ..... reserves ". He, accordingly, held that those items could not be taken into account for computation of the capital of the assessee-company. The Super Profits Tax Officer, on that basis, determined the capital, the standard deduction and levied super profits tax on that portion of the chargeable profits of the previous year which exceeded the standard deduction. Although the Appellate Assistant Commissioner, in first appeal by the assessee against the assessment, accepted the assessee's contention and held that those items were " other reserves ", the Income-tax Appellate Tribunal, in the appeal filed by the Super Profits Tax Officer against the order of the Appellate Assistant Commissioner, accepted the department's contention and held that they were not " reserves " within the meaning of the Second Schedule to the Act and those items could not enter into the computation of the capital of the assessee-company. At the instance of the assessee-company, the Income-tax Appellate Tribunal, under section 256(1) of the Income-tax Act, read with section 19 of the Super Profits Tax Act referred the following question of law to this Court : " Whether, on the facts and in the circumsta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Second Schedule, or Rs. 50,000, whichever is greater, is the " standard deduction " and the amount by which the former exceeds the latter, is chargeable to super profits tax at the rates specified in the Third Schedule. In the case before us, neither the quantum of chargeable profits determined by the Super Profits Tax Officer, nor the mode in which they have been computed, is in dispute. The only dispute that is raised in this reference is the one which relates to the computation of the capital for the purposes of determining the " standard deduction ". According to the accounting principle, the two bases of computation of capital are either the formula of capital plus reserves of the assets minus liabilities. The balance-sheet of a company is constructed on the principle that the capital, including reserves and undisclosed profits, is equal to the assets minus liabilities. In this equation, the capital is used in the sense of net wealth of the company representing the sum total or the capital, reserves and undistributed profits. In order to compute capital on the basis of the formula of capital plus reserves, it is essential to know the clear distinction that the law makes b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herwise requires,- (a) the expression 'provision' shall, subject to sub-clause (2) of this clause, mean 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 of which the amount cannot be determined with substantial accuracy ; (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 ; (c) the expression 'capital reserve' shall not include any amount regarded as free for distribution through the profit and loss account ; and the expression 'revenue reserve' shall mean any reserve other than a capital reserve ; and in this sub-clause, the expression 'liability' shall include all liabilities in respect of expenditure, contracted for and all disputed or contingent liabilities. (2) Where- (a) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nciples are applicable to the case before us, because the word " reserve " under the Super Profits Tax Act has been used and understood in the sense in which it has been used with reference to companies, under the Companies Act, 1956. In Workmen of William Jacks and Company Ltd. v. Management of William Jacks Co. Ltd., the Supreme Court in paragraph (8) of its judgment, reported at page 1825, held that : "The provision for gratuity, furlough salary, passage, service and commission in the present case was all made in respect of existing and known liabilities, though, in some cases, the amount could not be ascertained with accuracy. It was not a case where it was an anticipated loss or anticipated expenditure which would arise in future. Such provision is therefore, not a reserve at all and cannot be added back under item 2(c) of the Second Schedule. " Thus, in short, the amount set apart out of profits or 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". The amount set aside out of profits and other surpluses, to provide for any known liability, of which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f Rs. 5,08,637 which was not allowed in computing the profits of the assessee for the purposes of income-tax. In February, 1946, the directors recommended that, out of that amount, Rs 4,92,426 be distributed as dividends, and the balance be carried forward to the next year's account. The recommendation was accepted by the shareholders and dividends, shortly thereafter, were distributed. In computing the capital of the assessee-company on April 1, 1946, under the Business Profits Tax Act, the assessee claimed that the amount of Rs. 5,08,637 carried forward into the account of 1946 should be treated as " reserve " for the purposes of rule 2, sub-rule (1), of the Second Schedule to the Business Profits Tax Act. Ghulam Hasan J., speaking for the court, observed that : " ....the true nature and character of the disputed sum must be determined with reference to the substance of the matter .... nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on the 28th February, 1946 the directors clearly earmarked it for distribution as dividends and did not choose to make it a reserve. Nor did the company in its me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 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. " With those observations, the Calcutta High Court held that advance payments of tax under section 18A were not " reserves " within the meaning of rule 2 of Schedule II to the Business Profits Tax Act. To the same effect is the decision of the Gujarat High Court in Commissioner of Income-tax v. Rohit Mills Ltd. Follwing the principle laid down in Commissioner of Income-tax v. Century Spinning and Manufacturing Company Ltd., the question whether a particular fund is or is not a " reserve fund " must be determined with reference to the substance of the matter and not the terminology given to it. The Supreme Court in First National City Bank v. Commissioner of Income-tax held that funds reserev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... a few workmen because of retrenchment of surplus staff, was not a liability in praesenti in the year of account, but a liability which may arise de futuro on the happening of a particular contingency, and could not be allowed as a deduction either under section 10(2)(xv) or on commercial principles as to computation of profits. " In J. Dalmia v. Commissioner of Income-tax the board of directors of the company declared a dividend on August 30, 1950. The assessee (shareholder), received the dividend warrant on December 28, 1950. The date of declaration of the dividend fell within the assessment year 1951-52 of the shareholder, but the date of receipt of the dividend warrant fell within the assessment year 1952-53. The question arose whether the dividend income of the shareholder should be taxed in his hands in the assessment year, 1951-52 or 1952-53 ? The Supreme Court observed that : " A mere resolution of the directors resolving to pay a certain amount as interim dividend did not create a debt enforceable against the company, for it was always open to the directors themselves to rescind the resolution before payment of the dividend. " The word "paid " means that the company d ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntial accuracy, be determined ; (iv) it must not be retained to provide for depreciation, commitment, contingency or diminution in the value of the assets ; and (v) it must not have been allowed in the computation of the income for the purpose of income-tax. In the balance-sheet on the liabilities side, reserves for the current year have been shown at Rs. 1,44,49,159 as per Schedule I, and the current liabilities and provisions at Rs. 91,97,164 as per Schedule II. Although the terminology given by the assessee-company to those items is not the decisive factor for deciding the question, whether those items constitute " reserves " or " provisions ", still it is absolutely clear that the directors of the assessee-company have not chosen to earmark those amounts as " reserves ". In view of the ratio of the decision of the Supreme Court in Century Spinning and Manufacturing Company Ltd. the amounts not earmarked as " reserves " but which have been specifically earmarked as " dividends " have been held not to be taken into account for the computation of the capital. Apart from that, the liability to pay income-tax is a present liability, though it becomes payable at a future point ..... X X X X Extracts X X X X X X X X Extracts X X X X
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