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TMI Blog1981 (11) TMI 20X X X X Extracts X X X X X X X X Extracts X X X X ..... at account. The present reference before us is at the instance of the Department on the following question of law: " Whether, on the facts and in the circumstances of the case, the reserve for doubtful debts amounting to Rs. 1,02,995 (or such other amount as verified to be correct), should be included in working out the capital base for the purposes of surtax ? " The question falls to be considered on an understanding and appreciation of the Second Schedule to the C. (P.) S. T. Act, 1964. Questions of this nature have engaged the attention of this court and several other High Courts for some time. Reported decisions are legion. Recently, however, the Supreme Court had had occasion to consider this subject. They laid down the distinction, generally, between a provision and a reserve, and the accountancy principles bearing on the point. They then referred to the provisions of the Companies Act which deal with the matter from the point of view of the balance-sheet requirements. Finally, they took up the construction of the relevant provision of the Second Schedule to the Surtax Act. The decision of the Supreme Court is in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559. Ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... good or as bad. At the same time, there must be an indication in the balance-sheet that it is a doubtful debt, again, from the point of view of " true and fair ". Hence it is that a provision has to be made on the liabilities side of the balance-sheet of an amount equivalent in value to the doubtful debts, while such debts would continue to retain their position on the assets side. Doubtful debts are provided for in this manner by charging the profit and loss account. It is not done by making an appropriation, after the profit is struck in the profit and loss account. It is clear, therefore, that even where the balance-sheet nominally speaks of a "reserve for doubtful debts " it is really a provision. But the provision must be a real provision in the sense that the amount provided for is the end result of an evaluation of the doubtful debts and is equivalent to the sum total of the doubtful items alone. Where a lump sum or an ad hoc amount is charged to profit and loss towards doubtful debts, willy-nilly, and without regard for the recovery aspects, then it cannot be a provision; it is only a reserve. So too where there is an over-provision, as when good, debts also go into the re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... capital of the assessee under the Second Schedule to the Surtax Act. This is what the ITO held. We are also of the same view, because it fits in with the legal position now laid down by the Supreme Court in Vazir Sultan's case [1981] 132 ITR 559. The assessee's case, however, is that it is a reserve. The justification for its having to be treated as a reserve, according to the assessee, is provided by an important feature of the assessee's practice. It is said that every year bad debts are written off, not by debit to this so-called reserve, but by debit to the P & L a/c. Year after year, it is said, this " reserve is being only augmented, and is not " raided " at all for write-off of bad debts. In this very year ended April 30, 1972, we gather that the assessee wrote off something like Rs. 1,42,008,69, but that was also by debit to the P & L a/c. and not by debit to this particular " reserve ". This feature, it is urged, really makes the " reserve for bad debts " as good as its name. The suggestion is that the situation, in effect, is the same as if there is an ad hoc provision or an over-provision. We must reject this contention as unsound. The argument overlooks the intention ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ted as a reserve. The Tribunal gobbled up this argument. The Tribunal's reasons are to be found in an earlier order relating to this very assessee. The Tribunal adopted those reasons in the order now under reference. The reasons are reproduced below verbatim : " Here also it is clear that though the measure of the reserve is in terms of the amount considered as bad and doubtful debt, no specific tie-up of this item is noticed. On the other hand, this reserve is built up only for future contingency in case large bad debts had occurred and had to be written off. In other words, this is almost like dividend equalization reserve which is kept up only for future contingency when profits may not be enough to distribute to the shareholders. Only when necessity arises to draw from the reserve it is stated to be drawn from the reserve in other words this reserve will be continuing as reserve unless such a contingency as large bad debts arising and not capable of meeting out of the profits of the company had occurred." There is more than one flaw in this passage. The Tribunal have themselves pointed out that " the measure of the reserve " is " in terms of the amount considered as bad and d ..... X X X X Extracts X X X X X X X X Extracts X X X X
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