1981 (1) TMI 65 - HC - Income Tax

Summary

Issues:
1. Inclusion of reserves for bad and doubtful debts in the computation of capital under the Companies (Profits) Surtax Act, 1964.
2. Treatment of reserve for gratuity as part of the capital base under the same Act.

Analysis:
1. The first issue revolves around the inclusion of reserves for bad and doubtful debts in the computation of capital. The assessee included these reserves in their capital base for surtax assessment, but the Income Tax Officer (ITO) refused to treat them as part of the capital base. The Appellate Assistant Commissioner (AAC) considered these reserves as provisions rather than free reserves, as they were earmarked for specific liabilities. The High Court, referencing the decision in CIT v. Eyre Smelling P. Ltd., concluded that these reserves were made for anticipated contingencies and were not to be considered as reserves for computing capital under the relevant Act. The court highlighted that the provision was an anticipatory diminution in asset value and not a free reserve, ultimately ruling against the inclusion of bad and doubtful debts reserves in the capital computation.

2. The second issue pertains to the treatment of the reserve for gratuity in the capital computation. The AAC found that the provision for gratuity was made to meet specific liabilities to retiring employees and was not a free reserve. The court referred to the case of CIT v. Burn and Co. Ltd. and emphasized that for an amount to be considered a reserve, it should be available to the assessee for future business purposes. The court discussed the nature of current liabilities and provisions under the Companies Act and the Companies (Profits) Surtax Act, highlighting that certain liabilities, including gratuity, should be allowed as deductions under the Income Tax Act. The court rejected the contention that the provision for gratuity should be treated as a reserve, emphasizing that it was not available for future business purposes and was contingent on remote grounds. Therefore, the court ruled against the inclusion of the reserve for gratuity in the capital computation.

In conclusion, the High Court held that both reserves for bad and doubtful debts and gratuity were not to be included in the computation of capital under the Companies (Profits) Surtax Act, 1964. The judgment favored the revenue, and each party was directed to bear their own costs.