1981 (9) TMI 105 - SC - Income Tax

Whether amounts retained or appropriated or set apart by the concerned assessee-company by way of making provision, (a) for taxation, (b) for retirement gratuity, and (c) for proposed dividends from out of profits and other surpluses could be considered as other reserves within the meaning of r. 1 of the Second Schedule to the super Profits Tax Act, 1963 for inclusion in the capital computation of the company for the purpose of levying super profits tax ? Held that - the appropriation of the amounts set apart by the assessee-companies before us for taxation would constitute a provision made by them to meet a known and existing liability and as such the concerned amounts would not be includible in the capital computation. All the items, namely, gratuity, furlough salary, passage, service, commission, etc., were clearly in respect of liabilities which had already accrued in the years in which the provision was made and were not in respect of anticipated liabilities which might arise in future and, therefore, the court held that the said provision was not reserve but a provision In the context of the question whether while incurring any expenditure or making any disbursement a commercial concern will resort to current income or past savings, the normal rule, in the absence of express indication to the contrary, would be to resort to the current income rather than past savings. In our view, therefore, the Tribunal was right in excluding the sum of ₹ 3,10,450 from the general reserves while computing the capital of the assessee-company for the assessment year 1974-75 in the absence of express indication to the contrary. Civil Appeal is partly allowed and the issue whether the appropriation for retirement gratuity is a reserve or not is remanded to the taxing authority and the rest of the appeal is dismissed.

Issues Involved:
1. Whether amounts retained or appropriated for taxation, retirement gratuity, and proposed dividends can be considered "other reserves" under Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, or the Companies (Profits) Surtax Act, 1964, for inclusion in the capital computation of the company.

Issue-wise Detailed Analysis:

1. Provision for Taxation:
The primary issue was whether the amounts appropriated for taxation by the assessee-companies could be considered reserves. The court noted that the liability for taxation arises at the end of the financial year, even if the exact amount is not immediately ascertainable. The appropriation for taxation, therefore, represents a known liability, making it a provision rather than a reserve. This view was supported by the precedent in Kesoram Industries and Cotton Mills Ltd. v. CWT, which held that the liability for taxation is a present liability, despite the exact amount being determined later. Consequently, the amounts appropriated for taxation by the assessee-companies were deemed provisions and not reserves, thus excluded from the capital computation.

2. Provision for Retirement Gratuity:
The court examined whether the sum appropriated for retirement gratuity constituted a provision or a reserve. The court emphasized that ordinarily, an appropriation to gratuity reserve is a provision for a contingent liability, as the liability to pay gratuity arises upon the termination of employment. If the provision is based on an actuarial valuation, it represents a known liability and is a provision. However, if the sum appropriated is ad hoc and exceeds the estimated liability, the excess might be considered a reserve. The court remanded the issue to the taxing authorities to determine whether the amount set apart was based on an actuarial valuation or was an ad hoc sum.

3. Provision for Proposed Dividends:
The court considered whether amounts appropriated for proposed dividends could be regarded as reserves. It was noted that the directors' recommendation for dividend does not create an obligation or liability until approved by the shareholders. Thus, the amounts set apart for proposed dividends do not constitute provisions for any known liability. However, this does not automatically make them reserves. The court highlighted that the true nature and character of the appropriations must be determined by the intention and purpose behind them. The court concluded that appropriations for proposed dividends do not constitute reserves, as they are intended for distribution and not for future use or specific purposes.

4. Dividend Paid from General Reserve (Hyco Products Pvt. Ltd.):
In the case of Hyco Products Pvt. Ltd., the issue was whether the amount paid as dividend from the general reserve should be excluded from the capital computation. The court noted that typically, dividends are paid from current income rather than past savings unless explicitly stated otherwise. The court upheld the view that in the absence of an express indication, the amount paid as dividend should be excluded from the general reserve for capital computation purposes.

Conclusion:
The court dismissed Civil Appeal No. 1614(NT) of 1978 and Review Petition No. 57 of 1980, partly allowed Civil Appeal No. 860 of 1973 (remanding the issue of retirement gratuity), and answered the questions in the Tax Reference Cases Nos. 2 and 3 of 1977 and No. 5 of 1978 in favor of the department and against the assessee-companies. Each party was ordered to bear its own costs.

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