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Issues Involved:
1. Whether the Tribunal was justified in rejecting the claim that Rs. 25,38,694 represented a 'reserve' for the assessment year 1963-64. 2. Whether the Tribunal was justified in rejecting the claim that Rs. 25,88,011 represented a 'reserve' for the assessment year 1964-65. Issue-wise Detailed Analysis: Issue 1: Justification of Rs. 25,38,694 as 'Reserve' for Assessment Year 1963-64 The first issue pertains to the assessment year 1963-64, where the sum of Rs. 25,38,694 was shown as surplus in the balance-sheet of the assessee. The Tribunal rejected the claim that this amount represented a 'reserve' for the purpose of the Act. The Income Tax Officer (ITO) treated this amount as a mass of undistributed profits rather than a reserve. The Appellate Assistant Commissioner (AAC) upheld this view, stating that the surplus balance in the profit and loss account could not be treated as part of the capital fund of the assessee. The Tribunal, in its observations, noted that there was no specific amount transferred to any 'surplus account' and that the amount represented undistributed profits. The Tribunal emphasized that no company resolution or clear indication existed to show that the amount was intended to be a reserve. In reviewing the case, the High Court referred to the Supreme Court's decision in CIT v. Century Spg. and Mfg. Co. Ltd. [1953] 24 ITR 499, where it was held that undistributed profits not earmarked for any specific purpose could not be treated as reserves. The High Court also noted that the directors had not allocated the surplus to any particular purpose, making it a mass of undistributed profits rather than a reserve. However, the High Court considered the principles laid down by the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559, which emphasized the distinction between 'provision' and 'reserve' and the necessity to understand these terms in their commercial context. The High Court concluded that the sum of Rs. 25,38,694, though a mass of undistributed profits, should be treated as a reserve because the directors had decided not to earmark it for any specific contingency or purpose. Issue 2: Justification of Rs. 25,88,011 as 'Reserve' for Assessment Year 1964-65 The second issue pertains to the assessment year 1964-65, where the sum of Rs. 25,88,011 was claimed to be a reserve for working out the capital base of the company under Rule 1 of the Second Schedule to the C. (P.) S.T. Act, 1964. The ITO and AAC rejected this claim, treating the amount as undistributed profits. The Tribunal noted that the provisions of the Surtax Act for the second year were similar to those of the first year but included an Explanation in Rule 1 of the Second Schedule, which was not present in the previous year. The Tribunal rejected the assessee's appeal, relying on the same reasoning as for the previous year. The High Court examined the balance-sheet and directors' report for the year ended December 31, 1963, which indicated that the surplus as of December 31, 1962, was merged with the general reserve. The High Court referred to the Supreme Court's decision in CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566, which stated that the appropriation of profits to reserves by directors must be related to the beginning of the new accounting year and treated as effective from that date. The High Court concluded that the merging of the surplus as of December 31, 1962, with the general reserve must be effective from January 1, 1963. Therefore, the sum of Rs. 25,88,011 should be treated as a reserve for the assessment year 1964-65. Conclusion: For both assessment years, the High Court found that the Tribunal was in error in rejecting the claims that the sums represented reserves. The questions were answered in the negative and in favor of the assessee. The High Court emphasized the importance of understanding the terms 'reserve' and 'provision' in their commercial context and the intention behind the retention or appropriation of sums. The parties were ordered to pay and bear their own costs.
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