1996 (2) TMI 129 - SC - Income Tax

Whether the provision for taxation can be deducted from the cost of excluded investments and would, therefore, augment the capital base of the company for purposes of the Super Profits Tax Act, 1963, and the Companies (Profits) Surtax Act, 1964? Held that - In the present case there is no systematic accumulation of cash or any separation of assets to meet future tax liabilities. There is only an accounting entry of an exact sum being earmarked for payment of tax liability arising at the end of the current accounting year. Such a provision cannot be considered as a fund. The assessee, however, has submitted that the circular of the Board has taken the meaning of the term fund in its literal or etymological sense. We fail to see, how the circular helps the assessee in the case before us. A provision for taxation of the kind in question is not a fund either etymologically or in accounting parlance. The more relevant meaning of the term fund in the context of the two Acts is what that term is commonly considered to connote when used in a balance-sheet or profit and loss account of a company. A specific provision for an ascertained liability is not a fund within the meaning of that term in the rules in question. In favour of the Revenue

Issues Involved:
1. Whether the 'provision for taxation' is a reserve forming part of the capital under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.
2. Whether the 'provision for taxation' can be deducted from the cost of investments in computing the capital base under clause (ii) of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963.
3. Whether the 'provision for taxation' can be deducted from the cost of investments under rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964.

Detailed Analysis:

1. Provision for Taxation as a Reserve:
The first issue is whether the 'provision for taxation' can be considered a reserve forming part of the capital under rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. The Appellate Assistant Commissioner and the Tribunal concluded that the provision for taxation is not a reserve but an amount set aside to meet a liability accruing at the end of the accounting year. The High Court affirmed this view, stating that the provision for taxation cannot be treated as a reserve and thus cannot be included in the capital computation. This view aligns with the precedent set in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559, where it was held that a provision for tax liability does not represent a reserve.

2. Deduction from Cost of Investments under Super Profits Tax Act, 1963:
The second issue pertains to whether the 'provision for taxation' should be deducted from the cost of investments under clause (ii) of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963. The Tribunal held that the provision for taxation is neither a fund nor a surplus and is a provision against a "perfected debt," thus not qualifying for the deduction claimed by the assessee. The High Court, however, ruled in favor of the assessee, stating that the provision should be deducted from the cost of investments. The Supreme Court, upon review, concluded that such a provision does not qualify as a fund in the context of the balance-sheet and accounting practices, as it lacks systematic accumulation or separation of assets. Hence, the provision for taxation cannot be deducted from the cost of investments, overturning the High Court's decision.

3. Deduction from Cost of Investments under Companies (Profits) Surtax Act, 1964:
The third issue is whether the 'provision for taxation' can be deducted from the cost of investments under rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964. Similar to the second issue, the Tribunal denied the deduction, while the High Court ruled in favor of the assessee. The Supreme Court, however, found that the provision for taxation does not constitute a fund as understood in accounting parlance or under the Companies Act. The provision is merely an accounting entry for a specific liability and does not meet the criteria of a fund. Therefore, the Supreme Court held that the provision for taxation cannot be deducted from the cost of investments, aligning with its decision on the second issue.

Conclusion:
The Supreme Court allowed the Revenue's appeal, answering the questions in the affirmative and in favor of the Revenue. The provision for taxation is neither a reserve nor a fund and cannot be deducted from the cost of investments in computing the capital base under the relevant provisions of the Super Profits Tax Act, 1963, and the Companies (Profits) Surtax Act, 1964. There will be no order as to costs.

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