1996 (11) TMI 28 - HC - Income Tax

Summary

Issues Involved:
1. Classification of Debenture Redemption Sinking Fund as 'Reserve' or 'Provision' under the Companies (Profits) Surtax Act, 1964.

Detailed Analysis:

Issue 1: Classification of Debenture Redemption Sinking Fund as 'Reserve' or 'Provision'

Facts and Background:
For the assessment years 1974-75 and 1976-77, the Income-tax Officer excluded the debenture redemption sinking fund from the capital base, treating it as a 'provision' rather than a 'reserve'. The Commissioner of Income-tax (Appeals) upheld this decision, referencing Pickles on Accountancy and the Supreme Court's decision in Vazir Sultan Tobacco Co. Ltd. [1981] 132 ITR 559. The assessee appealed to the Tribunal, which reversed the decision, considering the fund a 'reserve'.

Tribunal's Findings:
The Tribunal based its decision on the following points:
1. The fund was recommended by the directors in their report and described as 'debenture redemption sinking fund' in the balance-sheet.
2. The fund was created out of surplus profit.
3. It was created in the profit and loss appropriation account, not the profit and loss account.
4. The fund did not diminish the assets of the assessee.
5. It appeared under 'Reserve and surplus' in the balance-sheet.
6. It was carved out from the surplus fund.
7. The fund would be reduced as debentures were redeemed, with any balance forming part of the general reserve.
8. The fund did not create a charge on the profit and was not an allowable deduction.

The Tribunal relied on the Karnataka High Court's decision in Addl. CIT v. Bharat Fritz Werner (P.) Ltd. [1979] 118 ITR 25, concluding the fund was a 'reserve'.

Department's Argument:
The Department argued that under the Explanation below rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, a sinking fund could not be considered a 'reserve'. They cited items (5), (6), and (7) under 'Reserves and surplus' in Schedule VI to the Companies Act, 1956, which include sinking funds. They also argued that the fund represented a provision for a known liability, i.e., debenture redemption.

Assessee's Argument:
The assessee contended that the fund was a 'reserve' since transfers were made from this account to the 'general reserve' annually. The fund was not represented by any specific investment, indicating it was set apart from profits to prevent distribution as dividends until debentures were repaid.

High Court's Analysis:
The High Court noted that the Tribunal did not consider whether the fund was available for business use until the redemption date, a vital factor as per CIT v. Lakshmi Mills Co. Ltd. [1996] 221 ITR 753. The High Court observed:
- The fund earned interest and included profits from debenture repurchases.
- As debentures were purchased and cancelled, corresponding amounts were transferred to the general reserve.
- The fund was included in the capital base as a 'reserve' for the relevant assessment years.

The High Court concluded that since the fund was available for business use and not earmarked solely for debenture redemption, it was a 'reserve' and not a 'provision'.

Judgment:
The High Court affirmed the Tribunal's decision, holding that the debenture redemption sinking fund was a 'reserve' and not a 'provision'. The question was answered in the affirmative, against the Department, with no costs awarded.