1980 (2) TMI 60 - HC - Income Tax

Summary

Issues Involved:
1. Definition and classification of "reserves" under the Super Profits Tax Act, 1963.
2. Whether the gratuity reserve of Rs. 3,35,000 created by the assessee-company should form part of its capital.

Detailed Analysis:

1. Definition and Classification of "Reserves" Under the Super Profits Tax Act, 1963:

The judgment discusses the importance of determining what constitutes "reserves" in the context of various tax legislations, such as the Business Profits Tax Act, the Super Profits Tax Act, and the Companies (Profits) Surtax Act. These Acts did not define "reserves," leading to judicial interpretations.

The judgment refers to the Supreme Court's interpretation in CIT v. Century Spinning and Manufacturing Co. Ltd. [1953] 24 ITR 499, which emphasized that "a reserve in the sense in which it is used in rule 2 can only mean profit earned by a company and not distributed as dividends to the shareholders but kept by the directors for any purpose to which it may be put in future."

Further, the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53 distinguished between "provisions" and "reserves," stating that "provisions made against anticipated losses and contingencies are charges against profits, and, therefore, to be taken into account against gross receipts in the P & L account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business."

The judgment clarifies that "provisions" are amounts set aside for known liabilities, while "reserves" are amounts set aside for future, contingent liabilities.

2. Whether the Gratuity Reserve of Rs. 3,35,000 Created by the Assessee-Company Should Form Part of Its Capital:

The case specifically addresses whether the gratuity reserve of Rs. 3,35,000 should be included in the capital base of the company under the Super Profits Tax Act, 1963. The Income Tax Officer (ITO) initially viewed this amount as a provision for a known contingent liability, not a reserve. However, the Appellate Assistant Commissioner (AAC) and the Tribunal disagreed, considering it a reserve since it was not allowed as a deduction under the Income-tax Act and was shown under "Reserves and Surplus" in the balance sheet.

The Tribunal's decision was based on the dictionary meaning of "reserve" and the fact that the amount was set aside to meet future gratuity payments, thus constituting a reserve.

The judgment also discusses relevant Supreme Court decisions, such as Kesoram Industries and Cotton Mills Ltd. v. CIT [1966] 59 ITR 767 and Standard Mills Co. Ltd. v. CWT [1967] 63 ITR 470, which addressed the nature of liabilities for gratuity payments. These cases clarified that such liabilities are contingent and not present debts, thus supporting the classification of the gratuity reserve as a reserve rather than a provision.

The court ultimately held that the amounts set apart by the assessee to meet its liability for gratuity should be treated as reserves, as there was no actuarial valuation or scientific estimation of the present value of the future liability. The sum of Rs. 3,35,000 was, therefore, considered part of the capital for the purposes of the Super Profits Tax Act.

The question referred to the court was answered in the affirmative, in favor of the assessee, and it was held that the gratuity reserve should be included in the capital base for the purposes of the Act. The court also noted that the issue was complex and decided that each party should bear its own costs.