1976 (7) TMI 43 - HC - Income Tax

Computation Of Capital Reserves, Computation Of Capital Reserves, Development Rebate Reserve, Development Rebate Reserve, General

Issues Involved:
1. Whether the sum of Rs. 2,10,000 was a reserve as of October 1, 1962, and thus not subject to the Explanation to rule 1 of Schedule II of the Companies (Profits) Surtax Act, 1964.
2. Whether the reserve for employees' indemnities was correctly treated as part of the reserves and capital for capital computation for surtax purposes.
3. Whether the excess reserve, though part of the development rebate in the balance-sheet, could be included in the capital computation for surtax purposes.

Detailed Analysis:

Issue 1: Sum of Rs. 2,10,000 as Reserve
The directors appropriated Rs. 2,10,000 towards the general reserve on February 27, 1963, approved by shareholders on March 31, 1964. The Income-tax Officer excluded this sum from the capital computation under the Explanation to rule 1 of Schedule II of the Companies (Profits) Surtax Act, 1964, treating it as a proposed addition to reserves. The Tribunal, however, accepted the assessee's contention that the amount was a reserve as of September 30, 1962, and thus includible in capital computation. The High Court upheld the Tribunal's view, referencing the Supreme Court's decision in Commissioner of Income-tax v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566 (SC), which stated that appropriations made by directors should be related back to the beginning of the accounting year. Thus, the sum of Rs. 2,10,000 was considered a reserve as of October 1, 1962, and includible in the capital computation for surtax purposes.

Issue 2: Reserve for Employees' Indemnities
The assessee-company appropriated Rs. 53,330.55 to a "reserve for employees' indemnities" to pay retrenchment compensation. The Income-tax Officer and the Appellate Assistant Commissioner treated this amount as a provision for a contingent liability, excluding it from the capital computation. The Tribunal, however, considered it a reserve, as there was no known liability for retrenchment compensation at the time. The High Court agreed, noting that the item did not appear under "Current liabilities and provisions" in the balance-sheet but under "Reserves and surplus." The Court emphasized that a reserve is an amount set aside not to meet any known liability, whereas a provision is for known liabilities. Thus, the amount was rightly includible in the capital computation for surtax purposes.

Issue 3: Excess Development Rebate Reserve
The balance-sheet disclosed a development rebate reserve of Rs. 1,66,077.25, while the statutory reserve required was Rs. 1,65,994. The Income-tax Officer included only the statutory reserve in the capital computation. The Tribunal included the entire excess reserve, stating that it formed part of the reserves and was entitled to be aggregated with capital for surtax purposes. The High Court supported this view, referencing a circular from the Central Board of Direct Taxes (Circular No. 53 dated January 11, 1971) which clarified that amounts credited in excess of statutory requirements constitute "other reserves" and are includible in the capital if not allowed in computing profits. Thus, the excess reserve was includible in the capital computation for surtax purposes.

Conclusion:
The High Court ruled in favor of the assessee on all three issues, directing that the department pay the costs of the reference to the assessee.

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