TMI Blog1961 (1) TMI 7X X X X Extracts X X X X X X X X Extracts X X X X ..... st the judgment and order of the High Court of Judicature at Bombay in Income-tax Reference No. 34 of 1956. The appellant is a non-resident bank incorporated under the National Bank Act of the United States of America with its head office in that country and with branches all over the world including some branches in India. It was assessed under the Business Profits Tax Act (XXI of 1947), hereinafter termed the " Act ", in respect of the chargeable accounting periods : April 1, 1946, to December 24, 1946 ; December 25, 1946, to December 24, 1947 ; December 25, 1947, to December 23, 1948 ; and December 24, 1948, to March 31, 1949 ; and the sole question for decision in this appeal is the meaning of the word " reserves " in rule 2(1) of Schedule II of the Act and how the capital of the appellant during the above mentioned chargeable accounting periods has to be computed for the purpose of allowing the " abatement " under the Act. The appellant contended that in computing the amount for the purpose of abatement, it was entitled to include what is termed in the United States " Undivided Profits ", the contention being that this item falls within the word " reserves " ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Appellate Assistant Commissioner excluded these amounts in determining the capital of the bank under rule 2(1) of Schedule II on the ground that they were not a part of the reserves of the bank. The appellant took an appeal to the Income-tax Appellate Tribunal which was dismissed on the ground that " Undivided Profits " meant nothing more than the " balance of the profit and loss account " and that no distinction could be drawn merely because in the nomenclature used in the United States, the amount was shown as " Undivided Profits " and not balance of the profit and loss account. At the instance of the appellant the following question of law was referred to the High Court : " Whether on the facts and in the circumstances of the case 'Undivided Profits' of $ 29,534,614.21 shown in the condensed statements of conditions as of December 31, 1946, can be treated as reserves and added to the capital, as required by rule 2(1) of Schedule II to the Business Profits Tax Act for the chargeable accounting period December 25, 1946, to December 24, 1947 ?" In its order the Tribunal said that the Treasury Rules in the United States divided capital account into four different heads, Capit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng that it was the result of an act of the directors that Surplus was increased and a particular sum was left in the Undivided Profits. It was contended that no sum could be treated as " reserves " unless the directors recommended it to be so allocated and it was so adopted by the shareholders. But this argument ignores the evidence placed by the appellant. Under the Treasury Rules of the United States of America containing "Instructions for Preparation of Reports of Condition by National Banking Associations", certain sums had to be specifically allocated under section 5211 of the revised Statute of the United States (Title 12, U.S.C. 161). Items 25 to 28, according to these instructions, deal with capital account. Item 26 deals with " Surplus " and item 27 with " Undivided Profits " and item 28 with " Reserves " (and retirement account for preferred stock). The following reserves came under item 28 : " (a) Reserve for dividends payable in common stock. (b) Reserves for other undeclared dividends. (c) Retirement account for preferred stock. (d) Reserves for contingencies, etc." Item 29 was as follows : "Total capital accounts". This item is the sum of items 25 to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... count of the requirements of the law. The " Undivided Profits " have to be employed in the manner indicated by the letter of the Deputy Controller of Currency. They are set up for expenses, taxes, dividends and reserves for continuous use in the business of the bank and are a part of the capital funds and an integral part of the capital structure and without it, it would not be possible to make an accurate computation. The reason for the existence of this fund, as shown by that letter is that when there are losses, they can be charged against " Undivided Profits " which expression means profits set apart after provision for expenses and taxes, etc., for continuous use in the business of the bank. There is a difference between the system of accounting of banking companies in India and the United States ; the failure to appreciate this difference has led the Appellate Tribunal as well as the High Court to arrive at an erroneous conclusion. In India at the end of an year of account the unallocated profit or loss is carried forward to the account of the next year, and such unallocated amount gets. merged in the account of that year. In the system of accounting in the U. S. A. each y ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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 be a general reserve or a specific reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits on the 1st January, 1946, cannot automatically make it a reserve .... A reserve in the sense in which it is used in rule 2 can only mean profit earned by a company and not distributed as dividend to the shareholders but kept back by the directors for any purpose to which it may be put in future ......." Applying this test t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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