1992 (4) TMI 99 - AT - Income Tax

Issues Involved:
1. Computation of chargeable profits and capital base for surtax purposes.
2. Enhancement of capital base by including the cost of spinning frames.
3. Application of Rule 1(iii) of the Second Schedule to the Surtax Act.
4. Classification and treatment of reserves and provisions.

Detailed Analysis:

1. Computation of Chargeable Profits and Capital Base for Surtax Purposes:
The assessee-company filed its surtax return for the assessment year 1981-82, disclosing chargeable profits of Rs. 8,57,698. The Assessing Officer, starting from the total income of Rs. 54,73,870, made necessary adjustments and determined the chargeable profits at Rs. 17,34,414. The capital base was computed as follows:
- Capital: Rs. 30,09,200
- General Reserve: Rs. 16,00,000
- Development Rebate Reserve: Rs. 5,52,893
- Investment Allowance Reserve: Rs. 2,21,119
- Total: Rs. 53,83,212
After applying Rule 1(iii) of the Second Schedule, the capital was reduced by the amount of depreciation allowed in excess of book depreciation, resulting in a capital base of Rs. 50,91,995. The excess of chargeable profit over the statutory deduction was computed at Rs. 9,70,615, and surtax was levied thereon.

2. Enhancement of Capital Base by Including the Cost of Spinning Frames:
The assessee argued that the capital employed as on 1-7-1979 should be increased by Rs. 8,84,773, representing the cost of six N.M.M. spinning frames. The Assessing Officer had treated the cost of these frames as capital expenditure and allowed depreciation of Rs. 2,22,192, resulting in a net augmentation of Rs. 8,84,773. The assessee contended that this amount should be added to the reserves, thereby increasing the capital base.

3. Application of Rule 1(iii) of the Second Schedule to the Surtax Act:
The assessee argued that Rule 1(iii) warranted the augmentation of the capital base by Rs. 8,84,773. However, the Assessing Officer and the CIT(A) rejected this argument, stating that there is no provision in the Act enabling such enhancement. The Tribunal noted that Rule 1(iii) is designed to reduce reserves by amounts allowed as deductions in computing income for income-tax purposes, not to increase them. The Tribunal also referenced the Supreme Court's decision in Vazir Sultan Tobacco Co. Ltd. v. CIT, which clarified the definitions of 'provision' and 'reserve'.

4. Classification and Treatment of Reserves and Provisions:
The Tribunal examined the scheme of the Companies (Profits) Surtax Act, 1964, noting that reserves play a significant role in computing the capital base. The Act does not define 'reserve', and the Companies Act, 1956 provides a negative definition. The Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT held that a 'provision' is an appropriation to meet known liabilities or depreciation, while a 'reserve' is an appropriation of profits earmarked for future use. The Tribunal concluded that the incremental sum of Rs. 8,84,773 could not automatically be treated as a reserve. It would remain a mass of undistributed profits unless explicitly earmarked as a reserve by the company's Board of Directors and approved by the shareholders.

The Tribunal also noted that the Explanation to Rule 1 of the Second Schedule specifies that surplus in the Profit & Loss Account after providing for proposed allocations shall not be regarded as a reserve for computing the capital base. Therefore, the lower authorities were correct in stating that the Surtax Act does not contemplate the augmentation of reserves in the manner proposed by the assessee.

Conclusion:
The Tribunal declined to interfere with the CIT(A)'s order and dismissed the assessee's appeal. The key takeaways are:
- The capital base cannot be augmented by amounts treated as capital expenditure and allowed as depreciation.
- Rule 1(iii) of the Second Schedule is intended to reduce reserves by amounts allowed as deductions, not to increase them.
- The classification of amounts as 'reserves' or 'provisions' must adhere to the principles laid down by the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT.
- Surplus in the Profit & Loss Account is not considered a reserve for computing the capital base under the Surtax Act.

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