1985 (7) TMI 161 - AT - Income Tax

Capital For Purposes, Chargeable Profits, Contingency Reserve, Development Rebate Reserve, Exchange Fluctuation, Foreign Exchange, Income Tax Act, Total Income

Summary

Issues Involved:
1. Computation of chargeable profits.
2. Computation of capital.
3. Deduction under rule 1(viii) for dividend income.

Issue-wise Detailed Analysis:

1. Computation of Chargeable Profits:
The primary issue was whether the amounts transferred to contingency reserve, foreign exchange fluctuation reserve, and development rebate reserve should be deducted from the chargeable profits. The assessee, a banking company, argued that these amounts should be treated as reserves and deducted from the income as per the profit and loss account. The ITO did not accept this plea, allowing deductions only for general reserves. The Commissioner (Appeals) accepted the assessee's plea, relying on the Delhi High Court decision in Addl. CIT v. Punjab National Bank [1983] 142 ITR 673 (Delhi), which held that contingency reserve was a reserve within the meaning of the Companies (Profits) Surtax Act, 1964. The Commissioner (Appeals) observed that rule 1(xi)(a) and rule 1(xi)(b) of the First Schedule to the Act were alternative provisions, and the banking company could claim either the sum transferred to a reserve fund under section 17(1) of the Banking Companies Act, 1949, or the sum transferred to any reserves in India, whichever was higher. The Commissioner (Appeals) directed that the higher amount should be deducted in computing the chargeable profits, resulting in an additional deduction of Rs. 449.78 lakhs.

2. Computation of Capital:
The Commissioner (Appeals) also considered the treatment of the balances in the contingency reserve, foreign exchange fluctuation reserve, and development reserve as on 1-1-1978 in the computation of capital under the Second Schedule to the Act. Relying on the Delhi High Court's decision in the case of the assessee, the Commissioner (Appeals) held that these balances were part of the capital for working out the standard deduction. The Supreme Court's guidelines in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559 were applied, indicating that reserves are appropriations of profit and not charges against profit. The Commissioner (Appeals) concluded that the contingency reserve, foreign exchange fluctuation reserve, and development reserve were reserves, and amounts transferred to these reserves had to be deducted in computing the chargeable profits and included in the capital computation.

3. Deduction under Rule 1(viii) for Dividend Income:
The issue was whether the gross amount of dividend income or the net amount after deducting expenses should be excluded under rule 1(viii) of the First Schedule. The Commissioner (Appeals) directed that the gross amount of dividend be deducted, relying on the Supreme Court's decision in Cloth Traders (P.) Ltd. v. Addl. CIT [1979] 118 ITR 243 and the Madras High Court decision in CIT v. Madras Motor & General Insurance Co. Ltd. [1975] 99 ITR 243. The departmental representative argued that the amendment in the Income-tax Act by insertion of section 80AA, which had retrospective effect, required the deduction to be made in respect of the dividend income as computed under the Income-tax Act. However, it was noted that for the purpose of surtax, an Explanation to rule 1 of the First Schedule, effective from 1-4-1981, provided that only the amount of income as computed under the Income-tax Act should be excluded. Since this Explanation was effective from 1-4-1981, for the assessment year 1979-80, the gross amount of dividend income was to be deducted. The Commissioner (Appeals)'s order was upheld, allowing the gross amount of dividend to be deducted.

Conclusion:
The order of the Commissioner (Appeals) was upheld in its entirety, and both the appeals were dismissed. The assessee's plea for treating contingency reserve, foreign exchange fluctuation reserve, and development rebate reserve as deductible reserves was accepted. The balances in these reserves were included in the capital computation, and the gross amount of dividend income was deducted in computing the chargeable profits.