TMI Blog1992 (5) TMI 17X X X X Extracts X X X X X X X X Extracts X X X X ..... t had to be excluded in computing the quantum of reserve as per Explanation to rule 1 of the Second Schedule to the said Act. The assessee filed an appeal to the Appellate Assistant Commissioner. It was contended that the said fund was not a sinking fund because, corresponding to this amount, there was no earmarked investment. The Appellate Assistant Commissioner came to the conclusion that the said fund was in the nature of a provision because it was provided for meeting a known liability arising in future. He held that the assessee had to draw up its balance-sheet in accordance with the accepted principles and, for that purpose, the Companies Act, 1956, laid down a form of balance-sheet in Schedule VI. He further observed that certain notes were given in the said Schedule which defined various items. It was provided therein that the expression " reserve " shall not include any amount written off or retained by way of providing for depreciation, renewals or diminution in the value of assets or retained by way of providing for any liability. He, accordingly, confirmed the order of the Income-tax Officer. In the second appeal, it was contended on behalf of the assessee that the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lows : " 7. (1) For the purposes of Parts I and 11 of this Schedule, unless the context otherwise 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 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 as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of Schedule VI to the Companies Act and observed that the expression " reserve " was negative in form and not exhaustive in the sense that it only specified certain amounts which were not to be included in the term " reserve ". After examining the two provisions, it opined that, if any retention or appropriation of a sum falls within the definition of " provision ", then it could not be a " reserve " but it did not follow that if the retention or appropriation is not a provision, then it automatically became a reserve. The substance of the matter had to be regarded and, in this context, the primary dictionary meaning of the term " reserve " may have to be availed of. Whether a particular amount constitutes a reserve or not will have to be decided by having regard to the true nature and character of the sum so created and depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriation had been made. In deciding whether the appropriation was a reserve or not, the Supreme Court held in Metal Box's case (sic) [1969] 73 ITR 53, that the following aspects provide some guidelines : " (a) a mass of undistributed profits cannot ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (ii) reserve for doubtful debts, (iii) super profits tax reserve, (iv) retirement gratuity reserve, and (v) dividend tax reserve. The Bombay High Court applied the decision of the Supreme Court in Vazir Sultan's case [1981] 132 ITR 559, and came to the conclusion that the contingency reserve consisted of amounts set apart to meet possible demands for excise duty and sales tax and as no assessment was ever made, no liability had ever accrued. These amounts were held to be includible in computing the capital. With regard to the super profits tax reserve, it was held that a correct computation should be made and only the excess amount would be regarded as a reserve. Similarly, with regard to the reserve for doubtful debts, it came to the conclusion that the said reserve had not been created on account of any possibility of debts becoming bad and, therefore, had to be included in the computation of the capital. With regard to the tax on dividend, it was observed that as on January 1, 1964, there was no law in force imposing any tax on dividend but an amount, as dividend tax reserve, had been set apart which must relate back to January 1, 1964, and, if that liability had to be paid, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ure redemption reserve, we fail to see how it can be said that there was any excess as such in this appropriation which could be taken as reserve. It is true that all the debentures had not become redeemable during the relevant previous years, but that does not make any difference because an amount set aside to meet a future liability, which was certain to come into existence, as in this case, must be regarded as a provision and not as a reserve. " Two other decisions of the Bombay High Court, also dealing with debenture redemption fund are again the cases of CIT v. National Rayon Corporation Ltd. [1986] 160 ITR 723 and CIT v. National Rayon Corporation Ltd. [1992] 193 ITR 577, where its earlier decision was followed. Dr. Pal, learned counsel for the assessee, relied upon a decision of the Karnataka High Court in the case of Addl. CIT v. Bharat Fritz Werner (P.) Ltd. [1979] 118 ITR 25. In that case, an amount had been transferred from the profit and loss appropriation account to the preference shares capital redemption reserve account which was created under section 80 of the Companies Act to meet the liability to repay capital covered by redeemable preference shares. It was he ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se, when the evidence clearly discloses that there was no liability at all on the assessee requiring it to set apart a sum as a charge against its profits and there was never any intention to make payments to the cane growers nor was any payment ever made, but, on the contrary, the assessee reversed the entries in a subsequent year in its books, it is apparent that the amount cannot be described as a 'provision'. It can only be described as a 'reserve'. It was part of the capital which fell for computation under rule 1 of the Second Schedule. " This conclusion was arrived at after the court reiterated that " reserve" was an appropriation of profits, the assets by which it is represented being retained to form part of the capital employed in the business, while a " provision " is a " present charge against the profits and the assessee continues to enjoy a proprietor's interest in the reserve. The said principle of law is clearly applicable to the present case also because redemption of debentures was not a present charge on the profits of the company in the year in question. In Elgin Mills' case [1986] 161 ITR 733 (SC), a question arose with regard to the inclusion of investment ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unt to the profit and loss appropriation account and the dividend was paid. The question was whether, for the previous year 1963 relevant to the assessment year 1964-65, the entire amount of Rs . 90 lakhs could be included in the capital computation as a reserve for the purposes of the Surtax Act. Approving the decision of the High Court, it was held by the Supreme Court that the resolution of the general body dated May 31, 1963, related back to the calendar year 1962 and, as on January 1, 1963, the sum of Rs. 76 lakhs was a provision and only Rs. 14 lakhs could be treated as a reserve. In arriving at this conclusion, it was observed by the Supreme Court that (at page 106) : " If an amount is set aside out of profits and other surpluses, not to meet any liability, contingency, commitment or diminution in the value of assets known to exist at the time of the balance-sheet, it was reserve. " (emphasis added). The question whether a debenture redemption fund was a reserve or provision also came up once again before the Calcutta High Court in the case of CIT v. Peico Electronics and Electricals [1987] 166 ITR 299. The Calcutta High Court referred to the decision of the Bombay High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 953] 24 ITR 499 (SC) as connoting any amount held back or set apart for a specific purpose as at a relevant date. On this interpretation, it is of no consequence what that specific purpose is or how long it is intended to hold back the amounts. But, even if this meaning is considered to be too wide and one proceeds on the basis of the observations of the Supreme Court in Metal Box's case [1969] 73 ITR 53, as providing a working definition, we think that the expression 'known liability', in the context of the Super Profits Tax Act, should be taken to refer only to a liability existing on the relevant date and not a future liability. We think so having regard to the nature and purpose of the legislation under consideration. The Business Profits Tax Act and the Super Profits Tax Act are pieces of legislation which operate on an annual basis. The purpose of ascertaining the capital is to work out the standard or statutory deduction available to an assessee by reference to the capital and reserves employed by the company in the business in the year of account. Having regard to the fact that this is an annual feature, it appears reasonable to say that what is relevant for the purposes of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... For one thing, unlike the Surtax Act which makes a reference to the definition, the Super Profits Tax Act avoids the incorporation of the said definition and since the Companies Act was of 1956, this must be taken to be deliberate. That apart, the purpose of the definition in the Companies Act is much wider and intended to safeguard the shareholders by ensuring that all possible liabilities of the company are provided for, as provisions to the extent of all known and foreseeable liabilities and as reserves to the extent of unforeseeable and unknown liabilities. That special definition may not, therefore, be imported here, particularly having regard to the object and purpose of the Act as explained earlier. We are, therefore, of the opinion that the expression 'known liability' should be construed as a reference to liabilities in praesenti and not future liabilities. " With respect, we are unable to agree with the Bombay High Court that the debenture redemption reserve is a " provision " and not " reserve ". The High Court in National Rayon's case [1986] 160 ITR 716 (Bom), has observed that (at page 721) : "the amount set apart to meet a future liability, which was certain to come ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not owed to anyone, as on the last date of the accounting year. Therefore, even if a liability is to arise in future but if a sum has been set apart for meeting that future liability, the said sum, during the year in which the liability has not arisen, has to be regarded as capital which is employed by the company. It was contended by Shri Rajendra that the decisions of the Calcutta and. Karnataka High Courts were clearly distinguishable because, as held by the Bombay High Court in National Rayon's case [1986] 160 ITR 716, the said cases dealt with the question of redeemable preference shares whereas in the present case we are concerned with the redemption of debentures. We, however, find that there is, in principle, no difference between the redemption of preference shares and redemption of debentures. In this regard, reference can usefully be made to the following observations of Gower in his book Principles of Modern Company Law, Fourth Edition, at page 418 : " The result is, that after lawyers have spent some 50 years trying to teach lay investors that there is a fundamental distinction between preference shares and debentures, the lawyers themselves have ended up by being ..... X X X X Extracts X X X X X X X X Extracts X X X X
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