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Issues: Determination of whether a certain sum can be called a reserve under the Business Profits Tax Act and inclusion of profits earned by a company in a specific period as reserves for tax purposes.
Analysis: The judgment by the Bombay High Court, delivered by Justices Chagla and Tendolkar, pertains to a reference under the Business Profits Tax Act involving the Century Spinning and Manufacturing Company Ltd. The primary issue was whether a sum of &8377; 5,08,637 carried over as balance to the balance sheet could be classified as a reserve as per Rule 2(1) in Schedule II of the Act. The rule defines capital as the sum of paid-up share capital and reserves not allowed in computing profits for income tax purposes. The court emphasized that reserves, in this context, refer to profits retained by a company and not distributed as dividends. The Advocate-General argued that for an amount to be considered a reserve, it must be appropriated for a specific purpose. However, the court disagreed, stating that the mere act of not distributing profits as dividends and keeping them back constitutes a reserve. Thus, the sum in question satisfied the requirements of Rule 2 and was deemed a reserve for tax purposes. Another issue addressed in the judgment was the inclusion of profits earned by the company from January 1, 1946, to April 1, 1946, as reserves for tax assessment. The court clarified that the focus should be on whether profits were consciously retained by the company, not merely earned. It rejected the argument that using profits in business automatically constituted reserves, emphasizing that reserves are profits intentionally kept back and not distributed as dividends. Since the company did not deliberate on retaining profits from the specified period, those profits could not be considered reserves under Rule 2 of the Act. Consequently, the court answered the first question affirmatively and the second question negatively, concluding the judgment without awarding costs for the reference.
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