1980 (12) TMI 39 - HC - Income Tax

Summary

Issues Involved:
1. Whether the amount distributed as dividend should be excluded in the computation of capital for statutory deduction under the Companies (Profits) Surtax Act, 1964.
2. Whether the board of directors' recommendation for dividend affects the computation of capital.
3. The interpretation of "reserve" and "provision" under the Companies Act, 1956, and their impact on the computation of capital.
4. The relevance of the general body meeting's approval in creating reserves and declaring dividends.
5. The applicability of the principle of "dating back" for reserves and dividends.

Detailed Analysis:

1. Exclusion of Dividend in Computation of Capital:
The central issue is whether Rs. 18,64,065, distributed as a dividend, should be excluded from the computation of capital for statutory deduction under the Companies (Profits) Surtax Act, 1964. The Tribunal held that this amount should not be included in the capital computation, and the court upheld this view. The court reasoned that the amount set apart for dividend, once declared by the general body, ceases to be a reserve and thus should not be included in the capital for surtax purposes.

2. Board of Directors' Recommendation for Dividend:
The court examined whether the board of directors' recommendation for dividend impacts the computation of capital. The court concluded that the recommendation by the board does not create a reserve; it is merely a proposal. The reserve is only created when the general body approves the recommendation and declares the dividend. Therefore, the amount recommended for dividend by the directors does not form part of the reserve until approved by the general body.

3. Interpretation of "Reserve" and "Provision":
The court discussed the distinction between "reserve" and "provision" under the Companies Act, 1956. A reserve is an amount set aside for future use by the company, while a provision is for a known liability. The court held that the amount set aside for dividend, once declared, is a provision and not a reserve. This interpretation was supported by the statutory provisions and accounting principles, which require proposed dividends to be shown under "Current Liabilities and Provisions" in the balance sheet.

4. General Body Meeting's Approval:
The court emphasized that the creation of reserves and the declaration of dividends are actions that require the approval of the general body. The board of directors can propose these actions, but they become effective only upon approval by the shareholders in the general meeting. This approval process ensures that the reserve and the dividend declaration are considered simultaneously, and the actual reserve is the amount remaining after the dividend is declared.

5. Principle of "Dating Back":
The court addressed the principle of "dating back," which was applied in the Supreme Court's decision in CIT v. Mysore Electrical Industries Ltd. The principle states that appropriations made by the directors relate back to the first day of the accounting year. The court extended this principle to the declaration of dividends, holding that the declaration of dividend by the general body also relates back to the first day of the accounting year. Therefore, the amount declared as dividend should be excluded from the reserve as of the first day of the year.

Conclusion:
The court concluded that the amount distributed as dividend should be excluded from the computation of capital for statutory deduction under the Companies (Profits) Surtax Act, 1964. The board of directors' recommendation does not create a reserve; it becomes effective only upon approval by the general body. The amount set aside for dividend, once declared, is a provision and not a reserve. The principle of "dating back" applies to both reserves and dividends, and the declaration of dividend relates back to the first day of the accounting year. The court answered the question in the affirmative, ruling against the assessee.