TMI Blog1978 (6) TMI 14X X X X Extracts X X X X X X X X Extracts X X X X ..... part. He held that the amounts standing in the general reserve account at the beginning of the year was a reserve for the purpose of capital computation. At the same time, he was not prepared to include the total sum of Rs. 28,43,984 shown under the head " General reserve " in the computation of the capital. Out of this, he excluded a sum of Rs. 4,00,000 which, according to him, was recommended by the directors to be paid as dividends from out of the general reserve and which recommendation was approved at the general body meeting held later. The appellate officer found that the dividends were also paid as proposed by the directors from out of general reserve. In the result, he held that the sum of Rs. 4,00,000 so paid should, therefore, be excluded from the computation of capital, since it was earmarked for payment of dividends and, therefore, only the balance of Rs. 24,43,984 should be treated as reserve to be included in the capital for the purpose of surtax. He also held that the sum of Rs. 1,93,577 shown in the balance-sheet under tax-free dividend reserve was a reserve to be included in the capital. To do this he relied on the decision of the Kerala High Court in CIT v. Peri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for assessment year 1971- 72) the general reserve of the assessee-company of Rs. 28,43,984 as on April 1, 1970, should stand reduced by Rs. 4 lakhs, being the dividend declared for year ended March 31, 1970, at the annual general meeting held on 26th August, 1970 ? " It also referred the following question at the instance of the department : " Whether, on the facts and in the circumstances of the case, 80K tax-free dividend reserve of Rs. 1,93,577 is eligible for inclusion in the computation of capital under the Companies (Profits) Surtax Act, 1964, for surtax assessment for the assessment year 1971-72 ? " These are the two questions which are to be answered now. In order to answer them, consideration of the material provisions of the C. (P.) S. T. Act, 1964, is necessary. This Act has been enacted for the purpose of imposing " a special tax on the profits of certain companies ". Section 4 of the Act is the charging provision. It enjoins that there shall be charged on every company, surtax in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mputing the capital of a company, certain reserves are permitted to be included in the amount along with the paid up share capital of the company. These reserves are described in cls. (ii) and (iii) of r. 1 of the Second Schedule. We are, in this case, concerned only with the reserves mentioned in cl. (iii). That sub-clause reads thus: " Its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (11 of 1922) or the Income-tax Act, 1961 (43 of 1961). " The Explanation to that rule declares 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 Sch. VI to the Companies Act, 1956, shall not be regarded as a reserve for the purpose of computation of the capital of a company under the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... will now very briefly refer to a few rulings. I start with the pronouncements of the Supreme Court in this aspect. In CIT v. Century Spinning and Manufacturing Co. Ltd. [1953] 24 ITR 499, the meaning of the word " reserve " as used in the Business Profits Tax Act came up for consideration. The Supreme Court laid down that the true nature and character of the disputed sum must be determined with reference to the substance of the matter and that therefore the sum in dispute in that particular case could not be called " reserve " as on the first day of April, 1946, since " nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination ". On the other hand, it was pointed out that the directors clearly earmarked the said sum for distribution as dividends. The next case, I would like to refer is Kesoram Industries and Cotton Mills Ltd. v. CWT [1966] 59 ITR 767 (SC). It arose under the W.T. Act. The directors of the company showed a particular amount as the amount of dividend proposed to be distributed for that year. However, the dividend was actually declared at the general meeting of the company some time later. The question which ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt gratuity to the employees of a company is a " reserve " or a " provision " for the purpose of the Surtax Act. After referring to the various decisions but without taking notice of the Metal Box Company's case [1969] 73 ITR 53 (SC), the learned judges held that the amount in question before them was not for any commitment which had already arisen or commitment of which had fallen due but was only a provision in regard to gratuity which might have to be paid to the employees as and when the liability might arise in future. A Full Bench of this court held in Hyderabad Asbestos Cement Products Ltd. v. CIT [1976] 105 ITR 822, that this view of the Kerala High Court does not represent the correct position in law. This court considered the question at some length in Vazir Sultan Tobacco Co. Ltd. v. CIT [1974] 96 ITR 248. It was a case which arose under the Super Profits Tax Act of 1963, and the question was that the provisions of certain amounts, (1) for taxation, (2) for retirement gratuity, and (3) for dividends, should be considered as " reserves " within the meaning of Sch. II to the S.P.T. Act, so that they could be considered for determination of the company's capital. The lear ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Kesoram Industries case [1966] 59 ITR 767 (SC). The problem before the Full Bench arose under the S.P.T. Act and related to the amount set apart for breakages and damages on sales and contingency and bonus. In that particular case these items were designated as " provisions " in the balance-sheet. The question was whether these amounts could be treated as " reserve " for the purpose of computation of capital. While deciding the question the Full Bench laid down the principles which distinguish a " provision " from " reserve ". It was pointed out that a " provision " does not acquire the character of " reserve " merely because the assessee has been carrying forward the balance in the provision account from year to year after meeting the liability, unless some person possessing requisite authority designated it as such or indicated the manner of the disposal or the destination of the balance amount concerned. Since no such designation had been made in the case before them, the learned judges held that the " provision " could not be treated as a " reserve " for 'the purpose of computation of chargeable profits. I may usefully refer to two decisions of the Bombay High Court which ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 40,000 could be included in the capital or in the income. It was held that the sum of Rs. 3,40,000 out of the dividend equalisation reserve amount was includible in the computation of capital as a " reserve " as on November 1, 1964, but not the sum of Rs. 5,20,000 transferred to the dividend equalisation reserve during the current year. Lastly I will refer to the Gujarat High Court's decision in CIT v. Mafatlal Chandulal Co. Ltd. [1977] 107 ITR 489. That was a case which arose under the S.P.T. Act. The question was whether amounts transferred to " taxation reserve " and " proposed dividend " were " reserves " and could be included in the computation of the capital of the company. It was held that the amount standing in the proposed dividend account was includible in computing the capital of the income. But the amount standing in the " provision for taxation account " was not so includible. It is not necessary to refer to more decisions since the legal position has been well established by the pronouncements of the Supreme Court and that of this court which are binding on us. The following guiding principles of law for the purpose of deciding what is " reserve " and what is " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd " reserve for super tax " in the balance-sheet of the assessee are in the nature of the items " provision for taxation " and " proposed dividends " and consequently they cannot be regarded as " reserve " for the purpose of computation of the capital. Therefore, the questions relating to the said two appropriations were answered against the assessee. The other appropriations relating to plant modernisation and rehabilitation reserve, loan redemption reserve and development rebate reserve were held to be " reserves " partaking of the nature of " capital ". Consequently, the revenue preferred the appeal to the Supreme Court in regard to these three items. However, the assessee chose to keep quiet. Consequently, the Supreme Court had to consider only about these three appropriations. The revenue contended that the appropriations having been made on 8th August, 1963, could not be treated as components of capital as on the first day of the previous year, viz., 1st of April, 1963, in terms of r. 1 to the Second Schedule. It was urged that on 1st April, 1963, these items only formed part of the mass of undistributed profits, no portion of which had been earmarked or set apart for any pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... g back to something which was not even in any embryonic form ? I, therefore, hold that the subsequent declaration of dividends from out of the general reserve cannot be related back to the date of the balance-sheet. The true nature and character of the entry in the balance-sheet is patently one of " reserve " and not of " provision ". The amount of general reserve, not to speak of the later declaration of a sum of Rs. 4,00,000 towards dividends from out of the general reserve, was not set apart to meet any liability, contingency, commitment or diminution in value of assets known to exist at the time of the balance-sheet. The board of directors and the general body of the shareholders may or may not declare any dividends. As on the date of the balance-sheet there was no known liability of which the amount cannot be determined with substantial accuracy so that it could be accepted as a " provision ". For these reasons, I hold that for the purpose of computing capital under the C. (P.) S. T. Act, 1964, for the assessment year 1971-72, the general reserve of the assessee-company of Rs. 28,43,984 as on April 1, 1970, shall not stand reduced by Rs. 4,00,000 and that the Tribunal was not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sheet shows transfers to general reserve, 80K tax-free dividend reserve, development rebate reserve and provision for taxes, all the sum put together, making up the total of Rs. 20,97,561. These three reserves including the " 80K tax-free dividend reserve " were shown in Sch. I to the balance-sheet under " reserves and surplus " while the provision made for taxes was shown in Sch. IV under the caption " Current liabilities and provisions ". As against the entries of proposed dividends on preference shares and equity shares, there was blank. That means there was no provision made for these dividends. What is significant is that there is no reference at all to the " 80K tax-free dividend reserve " in Sch. IV. Further, in the financial statement there is a five year review of the financial position of the company. One of the items shown in the review is " dividend for the year ". For the year 1970 only, the sum of Rs. 4,00,000 was shown. This must have been prepared subsequent to the preparation of the balance-sheet but it shows that only Rs. 4,00,000 were paid to the shareholders towards dividends and this sum of Rs. 1,93,577 representing " 80K tax-free dividend reserve " was not dis ..... X X X X Extracts X X X X X X X X Extracts X X X X
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