1997 (7) TMI 113 - SC - Income Tax

Whether a sum of 79 lakhs representing debenture redemption reserve was includible in computing the capital of the assessee-company for the purpose of the Companies (Profits) Surtax Act 1964? Held that The basic principle is that any amount retained by way of providing for a known liability will not be reserve . Explanation to rule 1 of the Second Schedule to the Surtax Act takes this principle to its logical conclusion by providing that even a sinking fund which has to be shown as a reserve in the prescribed form of balance-sheet will not be treated as reserve for the purpose of computation of capital. It is further to be noted that the surplus and unallocated balance in the profit and loss account has been specifically excluded from reserves for computation of capital under the Surtax Act. Therefore availability of the amount for utilisation as working capital of the company or for distribution of dividend cannot be a criterion for deciding whether a particular amount retained from the profits of the company will be treated as its reserve or not. Appeal dismissed.

Summary

Issues Involved:
1. Whether the debenture redemption reserve of Rs. 79 lakhs is includible in computing the capital of the assessee-company for the purpose of the Companies (Profits) Surtax Act, 1964.
2. Whether the sum of Rs. 6,66,159 appropriated to gratuity reserve should be treated as a reserve or provision.

Issue-wise Detailed Analysis of the Judgment:

1. Debenture Redemption Reserve:
The primary issue was whether a sum of Rs. 79 lakhs representing the debenture redemption reserve should be included in computing the capital of the assessee-company for the purpose of the Companies (Profits) Surtax Act, 1964. The High Court had previously determined that the amount set apart to redeem debentures should be treated as a "provision" and not as a "reserve." The court's reasoning was that the debenture redemption reserve was an amount set aside to meet a future liability, which was certain to come into existence, and thus must be regarded as a provision.

The Supreme Court agreed with the High Court's conclusion, emphasizing that an amount set apart to meet a known liability cannot be regarded as a "reserve." The definitions of "provision" and "reserve" under Part III, Schedule VI, of the Companies Act were pivotal in this determination. Specifically, clause 7(2)(b) clarified that only an amount in excess of what is reasonably necessary for meeting a known liability should be treated as a reserve and not as a provision. The directors' opinion on what is reasonably necessary is crucial, and opinions from accountants, auditors, or lawyers are immaterial.

The court noted that the amount set apart for redemption of debentures was less than the company's liability on this account. Therefore, the Rs. 79 lakhs representing the debenture redemption reserve could not be included in the capital of the company for surtax assessment. The court referenced the case of Vazir Sultan Tobacco Co. Ltd. v. CIT, which held that "provision" and "reserve" are concepts well-known in commercial accountancy and should be understood as per the Companies Act.

The court dismissed the argument that there was no present liability to pay any amount to the debenture-holders, stating that the liability to repay arises the moment the money is borrowed, even if the repayment date is deferred. The obligation is a present obligation, debitum in praesenti, solvendum in futuro. Thus, any money set apart to redeem the debentures must be treated as money set apart to meet a known liability.

The court also addressed contrary decisions from the Calcutta High Court in CIT v. Peico Electronics and Electricals and the Delhi High Court in CIT v. Modi Industries Ltd. (No. 2), which had treated the debenture redemption reserve as a reserve. The Supreme Court found these decisions erroneous, emphasizing that the liability to redeem the debentures was a known liability, even if the debentures were not redeemable during the accounting period.

The court further clarified that the Second Schedule to the Surtax Act, which lays down rules for computation of capital, excludes items under "current liabilities and provisions" from being regarded as reserves. The court highlighted that a sinking fund created for redemption of debentures is not treated as a reserve, even though it is shown as a reserve in the balance-sheet. Thus, a debenture redemption reserve should not be treated as a reserve for surtax purposes.

2. Gratuity Reserve:
In Civil Appeal No. 2970 of 1981, the issue was whether the sum of Rs. 6,66,159 appropriated to the gratuity reserve should be treated as a reserve or provision. The court referenced its decision in Vazir Sultan's case, which established that amounts set apart for known liabilities, such as gratuity, should be treated as provisions and not reserves. Consequently, the court held that the amount of Rs. 6,66,159 should be treated as a provision.

The court noted a point raised by the respondents that the amount set apart was more than what was actually required for the gratuity liability. However, the court did not express any opinion on this matter, as it was a question of fact and did not appear to have been raised before the High Court or the Tribunal. The assessee was allowed to raise this question before the Tribunal if it could lawfully do so.

Conclusion:
The Supreme Court dismissed the appeals, upholding the High Court's decision that the debenture redemption reserve could not be included in the capital of the company for surtax purposes. The court also ruled that the gratuity reserve amount should be treated as a provision. The decisions in the cases of Peico Electronics and Electricals and Modi Industries Ltd. (No. 2) were not upheld. The appeal concerning the gratuity reserve was allowed, with no order as to costs.