TMI Blog1998 (8) TMI 45X X X X Extracts X X X X X X X X Extracts X X X X ..... y for decision of the case as set out in the statement of case forwarded by the Income-tax Appellate Tribunal are as follows : The assessee is a company in which the public are substantially interested, where the State Government holds 83 per cent. of the paid-up capital. For the assessment year 1985-86, the assessee filed a return of chargeable profits under the Act declaring chargeable profits at "nil". The Deputy Commissioner of Income-tax (Assessment), Special Range, Trivandrum, who is the assessing authority, completed the assessment computing the chargeable profits at Rs. 71,49,980. The difference between the admitted figure and the assessed figure was Rs. 1 crore. This amount represented "loan redemption reserve " included by the assessee in the "capital employed". The assessing authority disallowed the same in the computation of capital. The assessee objected to the disallowance and carried the matter in appeal before the Commissioner of Income-tax (Appeals). The disallowance of the sum of Rs. 1 crore was affirmed by the said authority following the guidelines laid down by the Supreme Court in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 and Vazir Sultan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... agreed schedule of repayment of the loans and the interest thereon is found It page 41 of the paper book and it is admitted on both sides that the assessee had not kept to the schedule so far as repayment is concerned" (underlining supplied). Counsel further referred to annexure-D which is the annual report of the company relating to the financial year 1986-87 particularly "item No. 3, loan from State Government" and submitted that the statement of the company that it had obtained Rs. 491 lakhs from the Government of Kerala as loan between 1968 to 1973 and 1983 for the expansion of the titanium dioxide plant and that the company could repay only Rs. 115.50 lakhs till March, 1987, leaving a balance of Rs. 377.50 lakhs, clearly shows that there was an existing liability and that it is only towards repayment of that liability that the alleged loan redemption reserve is made. In support of his submissions, counsel relied on the decisions of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559 ; CIT v. Elgin Mills Ltd. [1986] 161 ITR 733 and State Bank of Patiala v. CIT [1996] 219 ITR 706. On the other hand, Sri. P. R. Raman, learned counsel appearing for the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nnexure-D, annual report of the company for the financial year 1986-87, item No. 3 in the directors' report that the company had obtained Rs. 491 lakhs from the Government of Kerala as loan between 1968 and 1973 and 1983 for the expansion of the titanium dioxide plant. It is also seen that up to March, 1987, the company could repay only a sum of Rs. 115.50 lakhs and that the balance of the loan outstanding as on March 31, 1987, was Rs. 377.50 lakhs which included a sum of Rs. 245 lakhs being overdue instalments of principal from 1983 onwards. It is further seen from the report mentioned above that out of the sum of Rs. 245 lakhs outstanding two instalments totalling Rs. 102 lakhs were repaid to the Government during June, 1987. The arrears due to the Government to wards principal of loan account as on the date of presentation of the report was Rs. 143 lakhs. Thus, from the report of the directors it is clear that the company had taken loans from the Government right from 1968 till 1983 and that there were occasional repayments in instalments though not regular. It is also evident that the total amount of loan outstanding was very substantial. The case of the assessing authority as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ear 1970 and every year Rs. 10 lakhs was set apart to the loan redemption reserve account up to and including the year 1980 excepting for the year 1979 and also noted that the total amount thus set apart came to Rs. 100 lakhs which remained under the head, "Loan redemption account" up to March 31, 1987, and thereafter, no amount was set apart under the said head. The details noted by the Tribunal in para. 5 also show that the Government loan outstanding as on December 31, 1970, was Rs. 121 lakhs and that the said loan amounts increased in the subsequent three years and thereafter it stood reduced to some extent and as on March 31, 1985, the amount outstanding was Rs. 461.25 lakhs. The Tribunal also referred to the Government orders whereby loans were sanctioned to the assessee and observed that it is seen that there was no stipulation by the Government for the creation of "loan redemption reserve". The Tribunal also found that the agreed schedule of repayment of the loans and the interest thereon is given at page 41 of the paper book and it is admitted on both sides that the assessee had not kept to the schedule so far as repayment, is concerned. The Tribunal also observed that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mate transfer of the loan redemption reserve to the general reserve in the year 1988, it can very well be concluded that the guidelines laid down by the Supreme Court in Vazir Sultan's case [1981] 132 ITR 559, are very well satisfied. The Tribunal also noted the fact that the amount appropriated was not against the profits but from out of the profits and that the loan redemption reserve did not bring any fresh liability because the liability was already in existence. It is further observed that the assessee's case is also supported by the decision of the Calcutta High Court in CIT v. Peico Electronics and Electricals [1987] 166 ITR 299, and that it is well settled that when there are two rival decisions one in favour of the assessee and the other against the assessee, the one that is favourable to the assessee can be adopted. The Tribunal accordingly directed the assessing authority to include the sum of Rs. 1 crore in the capital of the company for the purposes of surtax. Before proceeding with the matter further, it will be profitable to refer to the relevant provisions of the Companies (Profits) Surtax Act, 1964, which was enacted by Parliament with a view to impose a special ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Industrial Credit and Investment Corporation of India or any other financial institution which the Central Government may notify in this behalf in the Official Gazette or any banking institution (not being a financial institution notified as aforesaid) or any person in a country outside India : Provided that such moneys are borrowed for the creation of a capital asset in India and the agreement under which such moneys are borrowed provides for the repayment thereof during a period of not less than seven years. Explanation.---For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the heading 'Reserves and surplus' or of any item under the heading 'Current liabilities and provisions' in the column relating to 'Liabilities' in the 'Form of balance-sheet' given in Part I of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule." A reading of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the said sum must be treated as a reserve for the purpose of rule 2, but, the profit made by the assessee during the period from January 1, 1946 to April 1, 1946, could not be included in the reserves. On appeal, the Supreme Court held that the sum of Rs. 5,08,637 and the profit earned by the assessee during the period January 1, 1946 to April 1, 1946, did not constitute reserves within the meaning of rule 2(1) of Schedule II. The Business Profits Tax Act (No. XXI of 1947), came into force on April 11, 1947, which has taken the place of the Excess Profits Tax Act which was repealed on March 30, 1946. This Act was also designed to assess large profits made by companies carrying on business during the boom years of the war. Though the provisions of section 4 of the Business Profits Tax Act are not in pari materia, the expression "abatement" occurring in the definition of "taxable profits" mentioned in section 4 is defined in section 2(1) of the said Act to mean, in respect of any chargeable accounting period ending on or before March 31, 1947, a sum which bears to a sum equal to--- "(a) in the case of a company, not being a company deemed for the purposes of section 9 to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordinary natural meaning as understood in common parlance. Thereafter, the Supreme Court referred to the dictionary meaning of the word "reserve" as found in various dictionaries and observed as follows : "What is the true nature and character of the disputed sum, must be determined with reference to the substance of the matter and when this is borne in mind, it follows that on April 1, 1946, which is the crucial date, the sum of Rs. 5,08,637 could not be called a 'reserve' for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on February 28, 1946, the directors clearly earmarked it for distribution as dividend and did not choose to make it a reserve. Nor did the company in its meeting on April 3, 1946, decide that it was a reserve. It remained on April 1, as a mass of undistributed profits which were available for distribution and not earmarked as 'reserve'. On January 1, 1946, the amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The reserve may be a general reserve or a specific reserve, but there m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as follows : "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 and the 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 Regulation suggests 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 Do action to set aside any p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d that the amount designated as "undivided profits" was a part of the reserves and had to be taken into account when computing the capital and reserves under rule 2(1) of Schedule 11 to the Business Profits Tax Act. For arriving at the said conclusion, the Supreme Court applied the following observations of the Constitution Bench in Century Spinning and Manufacturing Company's case [1953] 24 ITR 499 : "It was held that the true nature and character of a sum disputed as reserve was to be determined with reference to the substance of the matter. The amount in dispute in that case was the profits after the deduction of depreciation and tax which amount was carried to the balance-sheet and was later recommended by the directors to be appropriated mainly to dividends and balance to be carried forward to the next year's account. Thus on the crucial date, i.e., April 1, 1946, from which the chargeable accounting period began the sum in dispute had not been declared as reserve ; on the other hand the directors had earmarked it for distribution as dividend and it remained as a mass of undistributed profits available for distribution. At page 504, Ghulam Hasan J. said : 'The reserve may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the account was intended for application in extending the business of the assessee-company. The amounts entered in the account "earned surplus" cannot therefore be regarded as mere unallocated profits at the end of the accounting year. The Supreme Court considered the question as to whether the appropriation of certain amounts under a scheme of gratuity by way of estimate towards liability to gratuity in the profit and loss account, amounts to a "reserve" or a "provision", in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53. In that case, the court observed as follows : "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 g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to these two words in the provisions of the Companies Act, 1956, dealing with preparation of balance-sheet and profit and loss account would govern their construction for the purposes of the two taxing enactments. The Supreme Court thereafter referred to the Constitution Bench decision in CIT v. Century Spinning and Manufacturing Co. Ltd. [1953] 24 ITR 499 (SC) and also the decision in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 and observed as follows : "The broad distinction between the two is that whereas a provision is a charge against the profits to be taken into account against gross receipts in the profit and loss account, a reserve is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business." Keeping the aforesaid broad distinction in mind, the court considered how the two concepts are defined and dealt with in the Companies Act, 1956. After referring to the definitions of "provision" and "reserve" ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is that while "provision" is a charge on profits which are taken into account in the gross receipts of the profit and loss account, "reserve" is an appropriation of profits to provide for the asset which it represented. It was also held that investment reserve and rehabilitation reserve were reserves and were entitled to be treated as such under the relevant Act. This court in CIT v. Haileyburia Tea Estates Co. Ltd. [1995] 214 ITR 770 applied Vazir Sultan's case [1981] 132 ITR 559, mentioned supra and held that the provision for gratuity shown as reserve in the balance-sheet has to be taken into account in computing capital. This court observed that the reasoning of the Supreme Court in Vazir Sultan's case [1981] 132 ITR 559, leads to the conclusion that the decision clearly lays down that the true nature and character of the appropriation must be determined with reference to the substance of the matter ; obviously, this means that one must have regard to the intention with which and the purpose for which the appropriation has been made, such intention and purpose being gathered from the surrounding circumstances. The Supreme Court had occasion to consider the question again in C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has to be examined." After adverting to the conclusion reached at page 746 of the report, it is observed as follows (page 394 of 219 ITR) : "At page 746 of the report applying the aforesaid principles to the case on hand, it was held that in the light of the facts found so far as bad and doubtful reserves were concerned the amounts set apart must be treated as a reserve. On the facts of the present case, as noted earlier, it could not be said that there was any ascertained liability for which a provision was made by creating the aforesaid reserve for bad and doubtful debts. In the present case, it was also not the Revenue's case that the amount set apart for bad and doubtful debts reserve was less than or equal to the amount necessary to be provided for meeting ascertained liability. On the other hand, the amount appeared to be more than what was reasonably necessary to be provided for in respect of the bad and doubtful debts as the amount of bad and doubtful debts itself was not an ascertained amount. Consequently, no fault can be found with the decision rendered by the authorities below and the High Court that the provision of Rs. 85,000 for doubtful debts had to be treated ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e decisions of the Supreme Court discussed above, the following guiding principles emerge : (a) A "provision" is different from "reserve". It need not necessarily follow that an amount set apart, if it is not a "provision", would automatically become "reserve". (b) "Provisions" 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. (c) The question whether the concerned amount constitutes reserves or not will have to be decided having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances particularly the intention with which or the purpose for which such appropriation had been made. (d) A mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ingly directed the assessing authority to include the sum of Rs. 1 crore in the capital of the company for the purposes of surtax. We are in full agreement with the reasoning and conclusion reached by the Tribunal. As on the date of creation of the loan redemption reserve the assessee owed a sum of Rs. 121 lakhs towards the loan taken from the Government. There was no obligation under the contract between the Government and the assessee to create a loan redemption reserve. The board of directors of the company had voluntarily created the reserve by making an appropriation of profit of Rs. 10 lakhs each year beginning from 1971. The appropriation of Rs. 10 lakhs every year was from out of the profits. The said reserve funds were internally invested in the business of the assessee there was no appropriation of any amount in the reserve account in the year 1979. The entire amount of Rs. 100 lakhs in the loan redemption reserve as on December 31, 1980, was ultimately transferred to the general reserve in the year 1988. It is relevant to note that the entire amount appropriated to the loan redemption account was not against the profits but from out of the profits. It is also relevant ..... X X X X Extracts X X X X X X X X Extracts X X X X
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