1949 (2) TMI 10 - HC - Income Tax

Summary

Issues Involved:
1. Interpretation of Rule 2 of Schedule II of the Excess Profits Tax Act.
2. Calculation of average capital employed in the insurance business.
3. Treatment of reserves for "unexpired risks" as debts or accruing liabilities.

Issue-wise Detailed Analysis:

1. Interpretation of Rule 2 of Schedule II of the Excess Profits Tax Act:
The primary issue revolves around the interpretation of Rule 2 of Schedule II of the Excess Profits Tax Act, which concerns the calculation of the average amount of capital employed in a business. The rule specifies that "any borrowed money and debt shall be deducted," including debts for income-tax, super-tax, or excess profits tax. The key question is whether reserves for "unexpired risks" in the insurance business should be treated as debts under this rule.

2. Calculation of Average Capital Employed in the Insurance Business:
The assessee-company, an insurance company, is required to calculate the excess profits tax payable for the accounting period from 1st September 1939 to December 1939. The calculation of standard profits involves applying the statutory percentage to the average capital employed during the chargeable accounting period. The dispute is about how to compute this average capital, specifically whether reserves for "unexpired risks" should be included or deducted.

3. Treatment of Reserves for "Unexpired Risks" as Debts or Accruing Liabilities:
The revenue authorities argue that the reserves for "unexpired risks" should be treated as debts and deducted from the capital. They contend that these reserves are "sums in respect of accruing liabilities" under Rule 2. Conversely, the assessee maintains that these reserves should be treated as part of the capital and not as debts. The court examines the nature of these reserves, which are maintained to cover potential claims arising after the accounting period. The court notes that these reserves are temporary and meant to cover unexpired risks, making it difficult to classify them as debts.

Judgment:
The court concludes that reserves for "unexpired risks" are not debts in respect of accruing liabilities. The court emphasizes that a liability becomes a debt only when it is payable, and until the contingency (the insured event) occurs, there is no liability. The court cites various legal precedents to support this interpretation, including decisions from the Judicial Committee and the House of Lords. The court also distinguishes between short-term and long-term insurance, noting that the reserves in question are temporary and specific to short-term insurance.

Conclusion:
The court answers the question in the negative, ruling that the sums standing to the credit of the different insurance funds as reserves for exceptional losses cannot be deducted under Rule 2 of Schedule II of the Excess Profits Tax Act. The reserves for "unexpired risks" are not considered debts or accruing liabilities, and thus should be included in the calculation of the average capital employed in the business.

Separate Judgments:
Das, J. concurs with the judgment.