1978 (6) TMI 14 - HC - Income Tax

Summary

Issues Involved:

1. Inclusion of Rs. 28,43,984 in the general reserve for capital computation.
2. Exclusion of Rs. 4,00,000 from the general reserve for dividend payment.
3. Inclusion of Rs. 1,93,577 in the 80K tax-free dividend reserve for capital computation.

Detailed Analysis:

1. Inclusion of Rs. 28,43,984 in the General Reserve for Capital Computation:

The assessee-company claimed that Rs. 28,43,984 shown in the balance-sheet under "general reserve" should be included in the computation of capital under Rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. The ITO excluded this amount, but the AAC partially upheld the assessee's claim by including Rs. 24,43,984, excluding Rs. 4,00,000 earmarked for dividends. The Tribunal upheld the revenue's contention to exclude Rs. 4,00,000, relying on the principle of relating back from CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566.

2. Exclusion of Rs. 4,00,000 from the General Reserve for Dividend Payment:

The Tribunal applied the principle of relating back, arguing that Rs. 4,00,000 recommended for dividends by the board of directors on June 30, 1970, and later ratified, should be excluded from the general reserve as of March 31, 1970. However, the High Court disagreed, stating that the principle of relating back does not apply here. The general reserve was not earmarked, and there was no known liability for dividends on the date of the balance-sheet. Therefore, the Rs. 4,00,000 should not be excluded from the general reserve for capital computation.

3. Inclusion of Rs. 1,93,577 in the 80K Tax-Free Dividend Reserve for Capital Computation:

The Tribunal included Rs. 1,93,577 in the capital computation, stating it was not earmarked for any particular purpose and was not a provision for a known liability. The High Court agreed, noting that the amount represented tax-free profits under Section 80J of the I.T. Act and was shown separately in the balance-sheet for clarity. It was not set aside for any liability or contingency, thus qualifying as a reserve for capital computation.

Conclusion:

The High Court answered the first question in the negative, stating that the general reserve should not be reduced by Rs. 4,00,000 for the purpose of computing capital under the Surtax Act. For the second question, the High Court answered in the affirmative, agreeing that Rs. 1,93,577 in the 80K tax-free dividend reserve is eligible for inclusion in the computation of capital. Both questions were answered in favor of the assessee, with each party bearing its own costs.