1981 (11) TMI 8 - HC - Income Tax

Summary

Issues:
Computation of capital under Sch. II of the Companies (Profits) Surtax Act, 1964 based on the treatment of general reserves in the context of dividend declaration and distribution.

Analysis:
The case involved a company with a calendar year as its account year that credited a specific amount to its general reserve and declared a dividend from the general reserves. The dispute arose during the assessment for surtax for 1972-73, where the Income Tax Officer (ITO) disagreed with the assessee's claim regarding the treatment of general reserves. The ITO contended that the dividend provision from profits of the previous year could not simultaneously be credited to the general reserve. The Tribunal upheld the ITO's decision, leading to the challenge by the assessee on the deduction of the dividend amount from the general reserve for capital computation.

The judgment referred to a Supreme Court decision in Vazir Sultan Tobacco Co. v. CIT [1981] 132 ITR 559, which clarified the distinction between reserves and dividends. The Supreme Court emphasized that a dividend involves releasing assets to shareholders, while reserves retain assets as company capital. The intention behind the allocation determines whether an amount in the reserve is earmarked for distribution as a dividend. Based on this principle, the court ruled in favor of deducting the dividend amount from the general reserve for capital computation.

The assessee's counsel argued about the introduction of Rule 1A in the Second Schedule to the Companies (Profits) Surtax Act, 1964, which addressed the treatment of proposed dividends in capital computation. However, the court dismissed the argument, stating that the Supreme Court's decision in Vazir Sultan's case was based on fundamental principles and that Rule 1A merely codified existing principles of corporate accounting.

The court emphasized that the Supreme Court's decision was binding, even though Rule 1A was introduced later. It highlighted that the rule aligned with the principles established by the Supreme Court regarding the impact of proposed dividend distribution on general reserves. Rule 1A mandated deductions from reserves for dividend distributions exceeding provisions made in the balance sheet, irrespective of the timing of the board's recommendation.

Ultimately, the court ruled against the assessee, aligning with the Supreme Court's interpretation and the application of Rule 1A in similar cases. The judgment concluded that the principles outlined by the Supreme Court regarding reserves and dividends were correctly reflected in Rule 1A, emphasizing the consistent application of these principles in capital computation under the Act.