1965 (10) TMI 24 - SC - Income Tax

Whether Tribunal was right in holding that the sum of 117, 000, 000 appearing in the balance-sheet of the assessee-company under the head Capital paid in Surplus and constituting the excess of the book value of the assets over the face value of the shares represented premium realised from the issue of the shares as contemplated by rule 3 of Schedule II of the Business Profits Tax Act 1947 ? Whether the Tribunal was right in holding that the fact that the amount in question had been built up out of capital and not out of taxed profits would not prevent it from being reserve as contemplated by sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act? Whether the Tribunal was right in holding that the sum of 29, 000, 000 odd 43, 000, 000 odd 56, 000, 000 odd and 73, 000, 000 and odd for the respective years appearing in the balance-sheets of the assessee as earned surplus would be treated as a reserve within the meaning of sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act ? Held that - The assets received by the assessee-company are real and tangible assets. It is only for accountancy purposes that a part of the value of the assets is allocated to the par value of the shares and the balance to the Capital Surplus brought in account. The High Court was therefore right in holding that the account Capital Surplus brought in in the balance-sheet represents premium realised from the issue of its shares within the meaning of rule 3 or in the alternative represents reserves not allowed in computing the profits of the company for the purpose of the Indian Income-tax Act 1922. The High Court was therefore right in holding that the earned surplus represented reserves. The method in which the accounts are maintained in the light of the accountancy practice clearly indicates that at the end of each year there have been specific appropriations in tne account and the conditions which this court regarded as essential in Century Spinning & Manufacturing Company s case for constituting the fund into reserve are fulfilled. Appeal dismissed.

Issues Involved:
1. Whether the sum of $117,000,000 under "Capital paid in Surplus" represented premium realized from the issue of shares as per rule 3 of Schedule II of the Business Profits Tax Act, 1947.
2. Whether the amount built out of capital and not taxed profits could be considered as a reserve under sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act.
3. Whether the sums of $29,000,000, $43,000,000, $56,000,000, and $73,000,000 in the balance-sheets as "earned surplus" could be treated as reserves under sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act.

Detailed Analysis:

Issue 1: Capital Paid in Surplus as Premium
The court examined whether the $117,000,000 listed as "Capital paid in Surplus" was a premium realized from the issue of shares under rule 3 of Schedule II of the Business Profits Tax Act, 1947. The court noted that in the United States, it is common for shares to be issued for consideration exceeding their par value, resulting in a "paid-in surplus." The court referenced various sources, including affidavits and corporate law texts, to support the view that the excess value of assets over the par value of shares could be regarded as a premium. The court concluded that the difference between the book value of the assets transferred and the par value of the shares issued was indeed premium, retained in the business, thus falling within the scope of rule 3 of Schedule II.

Issue 2: Capital Built from Non-Taxed Profits as Reserve
The court addressed whether the amount built from capital rather than taxed profits could be considered a reserve under sub-rule (1) of rule 2 of Schedule II. The court cited its earlier judgment in Commissioner of Income-tax v. Century Spg. & Mfg. Co. Ltd., noting that rule 2(1) does not explicitly require reserves to be built out of profits. The court emphasized that the Explanation to rule 2 excludes reserves created by revaluation of assets from being considered capital, but this did not apply to the present case as the assets were real and tangible. Consequently, the court held that the "Capital paid in Surplus" could be considered a reserve as it was not allowed in computing the profits of the company for income tax purposes.

Issue 3: Earned Surplus as Reserve
The court examined whether the "earned surplus" amounts in the balance-sheets could be treated as reserves under sub-rule (1) of rule 2 of Schedule II. The court noted that under the American accounting system, "earned surplus" is treated as a fund for business purposes, akin to a "general reserve" in Indian practice. The court distinguished this from the case in Century Spinning & Manufacturing Company Ltd., where unallocated profits were not considered reserves. The court found that the "earned surplus" in the assessee-company's balance-sheets represented specific appropriations for business use and retained its identity year after year. Therefore, the court concluded that "earned surplus" could be treated as reserves under rule 2(1) of Schedule II.

Conclusion:
The court upheld the High Court's affirmative answers to all three questions, dismissing the appeals with costs. The judgment clarified that both "Capital paid in Surplus" and "earned surplus" could be considered as reserves for the purposes of the Business Profits Tax Act, 1947, under the relevant rules.

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