1981 (11) TMI 31 - HC - Income Tax

Summary

Issues: Treatment of reserve for gratuity in the computation of capital under the Second Schedule to the Super Profits Tax Act, 1963.

Analysis:
The judgment delivered by the High Court of Madras addresses the issue of whether a reserve for gratuity should be considered as part of the capital for the purpose of capital computation under the Second Schedule to the Super Profits Tax Act, 1963. The case involved M/s. Crompton Engineering Co. (Madras) Ltd., which claimed that a sum of Rs. 7,75,000 shown as a reserve for gratuity on their balance sheet should be included in their capital. The Income Tax Officer (ITO) rejected this claim, stating that the provision for gratuity should be considered as a current liability and not as part of the capital. The Tribunal, however, allowed the claim on appeal, considering the amount as a reserve to be added to the paid-up capital of the company. The key question before the High Court was whether the reserve for gratuity should be included in determining the capital base for super profits tax assessment for the relevant assessment year.

The High Court referred to a recent decision by the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559, which laid down important principles regarding the distinction between reserves and provisions. The Supreme Court emphasized that a reserve is an appropriation of profits created to meet unknown contingencies, while a provision is a charge against profits created to meet known liabilities. The Court highlighted that provisions for gratuity should be made on scientific principles and should be considered as charges against profits, not reserves.

The Supreme Court's decision emphasized that ad hoc provisions for gratuity should be regarded as provisions and not reserves. The High Court of Madras noted that previous decisions by the High Court, such as CIT v. Indian Steel Rolling Mills Ltd. [1973] 92 ITR 78 and others, had considered ad hoc amounts set aside for gratuity as reserves. However, the High Court acknowledged that the Supreme Court's ruling superseded these decisions, clarifying that all ad hoc appropriations for gratuity should be treated as provisions.

In light of the Supreme Court's decision, the High Court of Madras concluded that the nature of the appropriation for gratuity in the case at hand was unclear. The Tribunal's decision to treat it as part of the capital base without examining the nature of the appropriation as per the Supreme Court's guidelines was deemed incorrect. Therefore, the High Court answered the question in the negative, indicating that the matter needed to be reconsidered by the Tribunal in accordance with the principles laid down by the Supreme Court. The Tribunal was given the discretion to remand the case to the ITO for further examination or allow additional evidence to be presented for a proper determination.

In conclusion, the High Court disposed of the reference without costs, emphasizing the need for a thorough reevaluation of the appropriation for gratuity in line with the principles established by the Supreme Court, ensuring a clear distinction between reserves and provisions in the computation of capital under the Second Schedule to the Super Profits Tax Act, 1963.