1986 (7) TMI 87 - SC - Income Tax

Whether (a) investment reserve, (b) rehabilitation reserve, and (c) forfeited dividend reserve were includible in the capital computation of the company in accordance with the Second Schedule to the Companies Profits (Surtax) Act, 1964? ? Held that - The distinction between provision and go reserve is that while provision is a charge on profits which are taken into account in the gross receipts of the profit and loss account, If reserve is an appropriation of profit to provide for the asset which it represented. Keeping these tests and the facts of these appeals in mind, we must hold that the conclusion of the High Court holding that the investment reserve and rehabilitation reserve were reserves and were entitled to be treated as such under the relevant Act is right. But on the facts of the case, the High Court was not right in holding that the forfeited dividend reserve was a reserve and question No. 2 is also answered in the affirmative. It should have followed in this respect its previous decision in respect of Forfeited Dividend reserve in CIT v. British India Corporation 1972 (7) TMI 22 - ALLAHABAD High Court . The appeal, therefore, fails except on the point of Forfeited Dividend reserve.

Summary

Issues Involved:

1. Whether the Tribunal was correct in applying the principles of the Super Profits Tax Act, 1963, instead of the Companies Profits (Surtax) Act, 1964, for the computation of capital.
2. Whether the investment reserve, rehabilitation reserve, and forfeited dividend reserve should be included in the capital computation under the Companies Profits (Surtax) Act, 1964.
3. The distinction between "provision" and "reserve" and its application to various reserves like investment reserve, rehabilitation reserve, capital reserve, depreciation reserve, and forfeited dividends.

Issue-wise Detailed Analysis:

1. Application of Principles from the Super Profits Tax Act, 1963:

The Tribunal applied the principles from the Super Profits Tax Act, 1963, for the computation of capital under the Companies Profits (Surtax) Act, 1964. The High Court noted that the provisions of both Acts were similar, with the main difference being the terminology used ("standard deduction" in the Super Profits Tax Act, 1963, and "statutory deduction" in the Companies Profits (Surtax) Act, 1964). The High Court found that the Explanation added to the Second Schedule of the Companies Profits (Surtax) Act, 1964, merely clarified what was implicit in the Super Profits Tax Act, 1963. Therefore, the Tribunal's approach was upheld.

2. Inclusion of Specific Reserves in Capital Computation:

The Tribunal included the investment reserve, rehabilitation reserve, and forfeited dividend reserve in the capital computation. The High Court affirmed this decision for the investment and rehabilitation reserves but disagreed regarding the forfeited dividend reserve. The High Court referred to its previous judgment in CIT v. British India Corporation P. Ltd., which distinguished between "provisions" and "reserves." The High Court concluded that while the investment and rehabilitation reserves were genuine reserves, the forfeited dividend reserve was a provision for an existing liability, not a reserve. Therefore, the forfeited dividend reserve should not be included in the capital computation.

3. Distinction Between "Provision" and "Reserve":

The Supreme Court reiterated the principles established in previous cases, such as Vazir Sultan Tobacco Co. Ltd. v. CIT and Metal Box Co. Ltd. v. Their Workmen. A "reserve" is an appropriation of profits retained for future use, while a "provision" is a charge against profits for known liabilities. The Court emphasized that the intention behind setting aside amounts and the nature of the liabilities were crucial in determining whether an amount was a reserve or a provision. The Court held that the investment reserve, rehabilitation reserve, capital reserve, and depreciation reserve were genuine reserves. However, the forfeited dividends reserve was a provision for an existing liability and should not be treated as a reserve.

Conclusion:

The Supreme Court upheld the High Court's decision that the investment reserve and rehabilitation reserve were genuine reserves and should be included in the capital computation under the Companies Profits (Surtax) Act, 1964. However, the forfeited dividend reserve was a provision for an existing liability and should not be included. The appeals were dismissed except for the point regarding the forfeited dividend reserve. Each party was ordered to bear its own costs.