TMI Blog1979 (1) TMI 14X X X X Extracts X X X X X X X X Extracts X X X X ..... taken with regard to the provisions and the reserves to be made in the accounts for the year ended 30th November, 1962: (i) Rs. 70,039 were to be appropriated to the reserves for bad and doubtful debts making an aggregate total of Rs. 1,08,099 in the reserves for bad and doubtful debts calculated on the basis of all debts outstanding over a year as also at 1 1/2 per cent. on the balance of the trade debts. (ii) Rs. 4,08,731, which was a provision for staff gratuity, were transferred to reserve for staff gratuity as from 1st December, 1961. (iii) Rs. 86,545 were to be appropriated to the reserve for staff gratuity. (iv) Rs. 11,580 we're to be appropriated for reserve for terminal pay. (v) Rs. 16,02,675 were to be appropriated to tax exempt dividend reserve under s. 84 of the I.T. Act, 1961. (vi) Rs. 76,25,519 out of a total amount of Rs. 78,16,689 to the credit of the profit and loss account were to be transferred to the account of general reserve as from 1st December, 1961. (vii) Rs. 15,22,168, being the surplus for the year ended 30th November, 1962, were to be transferred to the general reserve making an aggregate total of Rs. 91,47,687. The accounts of the compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set apart as relating to profits exempt from tax under s. 84 so that the working out of exemption of dividend in terms of s. 85 may be facilitated by such segregation and it was not an amount retained by way of providing for any known liability and it did not, therefore, constitute a provision but was a reserve and was properly includible in the computation for S.P.T. purposes. With regard to the amount of Rs. 43,05,000 by way of proposed dividends, the Tribunal found that this amount was not at any stage labelled as a reserve by the directors and the directors had earmarked this amount for distribution as dividend. Thus, the amount having been provided for a specific purpose of meeting the liability on account of payment of dividend, the Tribunal held it could not be said to be includible as a reserve for the purposes of computation of capital. The assessee-company and the revenue both being aggrieved by the order of the Tribunal sought reference of certain questions to this court and, accordingly, the following questions have been referred to this court: At the instance of the assessee : " 1. Whether, on the facts and in the circumstances of the case, the reserves for termin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to deal with that question further. We shall now deal with the other questions. As already pointed out, s. 4 of the S.P.T. Act of 1963 provides for charging a tax called " super profits tax " on every company for every assessment year commencing on and from the 1st day of April, 1963, in respect of so much of its chargeable profits of the previous year as exceed the standard deduction at the rate or rates specified in the Third Schedule. Section 2(5) defines the expression " chargeable profits " to mean the total income of an assessee computed under the I.T. Act, 1961, for any previous year and adjusted in accordance with the provisions of the First Schedule. Section 2(9) defines the expression " standard deduction " to mean an amount equal to six per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of fifty thousand rupees, whichever is greater. Therefore, in order to determine " standard deduction ", it becomes necessary to compute the capital of the company in accordance with the rules laid down in the Second Schedule, the material provision of which is r. 1. The relevant part of r. 1 reads as follows: " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t compensation in future. There is no known liability for retrenchment compensation, nor is there evidence to show that there was any demand for retrenchment compensation likely to arise in respect of which this provision can be said to have been made. If this is merely an amount set apart for a possible claim for retrenchment compensation which may or may not arise in future and it was not in respect of any known liability, it is difficult to see how this amount can be treated as provision. If it is not in respect of any known liability, then, in our view, it had to be treated as a reserve. A similar question arose in CIT v. Otis Elevator Co. (India) Ltd. [1977] 107 ITR 241 (Bom). The company in that case had been appropriating various sums to an account called " Reserve for Employees' Indemnities " and this reserve was created in order to pay retrenchment compensation arising out of any retrenchment of any member of the staff. The ITO had not considered this item as a reserve for the purpose of computation of capital for surtax purposes treating it as in the nature of a contingent liability. That amount was subsequently transferred to the gratuity ,reserve and it had become a p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... them to be in the nature of a reserve and not provision because the appropriations were made on an artificial basis hundred per cent. for the dues remaining unpaid for over a year and a one and half per cent. for dues unpaid for less than a year. In their opinion, real liability for bad and doubtful debts could have certainly no relation to the basis of the provision. Moreover, whatever debts actually became bad were never debited to this account and were always debited to the regular profit and loss account of each year. " These observations were relied upon by Mr. Dastur in order to draw our attention to the fact that it had been the practice of the assessee not to debit the amount of debts which had become bad to the reserve created for bad and doubtful debts, but to the profit and loss account. Now, the decision of the board of directors which is on record as annex. " A " to the statement of case shows that all debts outstanding for over a year have been treated as bad and doubtful debts and so far as debts outstanding for a period of less than a year were concerned, the amount of the reserve was computed at 1 1/2 per cent. of those debts. It is obvious, therefore, that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o way different. As already pointed out, the amounts were determined on an ad hoc basis. There was no existing liability, nor was there any known liability, because it was never ascertained as to which debt was likely to become a bad debt and the practice of the company was to debit bad and doubtful debts to the profit and, loss account and not to the reserve in question. The assessee was, therefore, entitled to have the amount of Rs. 38,060 which was treated as a reserve for bad and doubtful debts to be included in the computation of capital for super profits tax purposes. The third question relates to the staff gratuity reserve of Rs. 4,08,731. Now, even in respect of the amount carried over to the gratuity reserve, it is obvious that it was not in respect of any present or known liability and while creating that reserve and appropriating that amount to the reserve, no attempt was made by the assessee-company to estimate any present liability on an actuarial basis. The reserve created is really and in substance on the footing that some claim for gratuity might arise in future Such an appropriation could not, in our view, be treated as a provision. We may refer with advantage to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Shree Ram Mills Ltd. v. CIT [1977] 108 ITR 27. It was held in that case that the amount specifically set apart for the purposes of distributing dividend by the directors could not be treated as a reserve and it was, therefore, not liable to be included in the capital computation under r. 1 of Sch. II to the S.P.T. Act, 1963. A similar view has been taken by the Madras and Calcutta High Courts in Madras Auto Service v. CIT [1978] 112 ITR 540 (Mad) and Braithwaite and Co. (India) Ltd. v. CIT [1978] 111 ITR 729 (Cal). Mr. Dastur, the learned counsel appearing for the assessee, has, however, argued that a contrary view has been taken by the Gujarat High Court in CIT v. Mafatlal Chandulal Co. Ltd. [1977] 107 ITR 489. It is no doubt true that in this case the Gujarat High Court has taken the view that the amount standing in the proposed dividend account had to be taken into account in computing the capital for the purposes of r.1 of Sch. II to the S.P.T. Act, 1963. We would, however, prefer to follow the decision of our High Court in Shree Ram Mills Ltd.'s case [1977] 108 ITR 27. Question No. 4 must, therefore, be answered against the assessee. The only other question which n ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the capital computation for super profits tax purposes. Question No. 6-The tax exempt dividend reserve of Rs. 1,91,170 is properly includible in the capital computation for super profits tax purposes. Since the assessee succeeds substantially in this reference, the assessee shall get the costs of this reference from the revenue. I.T. Reference No. 65 of 1970 (Chandurkar Desai JJ.) (24-1-1979) The assessee in this reference is the same as in Income-tax Reference No. 69 of 1970 decided today. The assessment proceeding for the purposes of determining surtax liability was, however, in respect of the assessment year 1964-65, i.e., the year next to the one in respect of which Income-tax Reference No. 69 of 1970 arose. The questions referred to us are also identical so far as the nature of the reserves is concerned, These questions are as follows: At the instance of the assessee " (1) Whether, on the facts and in the circumstances of the Case, the reserve for terminal pay of Rs. 85,859 is not includible in the capital computation for surtax purposes ? (2) Whether, on the facts and in the circumstances of the case, the reserve for bad and doubtful debts of Rs. ..... X X X X Extracts X X X X X X X X Extracts X X X X
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