1970 (2) TMI 3 - HC - Income Tax

Whether the development rebate reserve created by the company by duly discharging the amount to the profit and loss account and being allowable under the Act constituted accumulated profits of the company within the meaning of section 2(6A)(e) - Held, yes

Issues Involved:
1. Whether the development rebate reserve constitutes "accumulated profits" under section 2(6A)(e) of the Indian Income-tax Act, 1922.
2. Whether only the development rebate reserve for the accounting year 1957 constitutes "accumulated profits" to the exclusion of earlier years.
3. Whether the debit balance in the mutual, open, and current account represents an advance or loan within the meaning of section 2(6A)(e).
4. Whether only the amount outstanding at the end of the accounting year should be considered for the purposes of section 2(6A)(e).

Analysis of Judgment:

Issue 1: Development Rebate Reserve as "Accumulated Profits"
The court examined whether the development rebate reserve created by the company qualifies as "accumulated profits" under section 2(6A)(e) of the Act. The Tribunal initially held that development rebates are not accumulated profits. However, the court disagreed, stating that development rebate, although allowed as a deduction under section 10(2)(vib), continues to retain its character as profits until it is actually used for development. The court emphasized that the object of development rebate is to encourage capital formation through savings out of current profits, thus it forms part of the real profit and should be included in "accumulated profits."

Issue 2: Development Rebate Reserve for 1957 Alone
The court addressed whether only the development rebate reserve for the accounting year 1957 should be considered "accumulated profits" to the exclusion of earlier years. The court clarified that "accumulated profits" mean profits accumulated before the beginning of the accounting year relevant to the assessment year. Therefore, the development rebate reserve for the accounting year 1957 cannot be isolated from those of earlier years. The court concluded that "accumulated profits" must include profits accumulated prior to the relevant accounting year.

Issue 3: Debit Balance as Advance or Loan
The court analyzed whether the debit balance in the mutual, open, and current account of the assessee with the company represents an advance or loan under section 2(6A)(e). The court stated that each debit entry must be individually considered to determine if it constitutes a loan. The account showed both credits and debits, and the court emphasized that only payments by the company that exceed its existing debt to the assessee can be considered loans. Thus, the court concluded that the balance in the account alone does not determine the nature of the payment; each payment must be analyzed individually.

Issue 4: Amount Outstanding at the End of the Accounting Year
The court considered whether only the amount outstanding at the end of the accounting year should be taken into account under section 2(6A)(e). The court rejected this approach, stating that the position must be ascertained at the date of each payment by the company to the assessee. The court reasoned that if only the year-end balance were considered, it could lead to contradictions, such as large borrowings during the year being ignored if repaid by year-end. Therefore, every payment during the accounting year must be evaluated to determine if it constitutes a loan or advance.

Conclusion:
The court answered the questions as follows:
1. Question No. 1: Affirmative - The development rebate reserve constitutes "accumulated profits."
2. Question No. 2: Negative - The development rebate reserve for 1957 alone does not constitute "accumulated profits" to the exclusion of earlier years.
3. Question No. 3: Negative - The balance in the account does not represent an advance or loan; each payment must be individually considered.
4. Question No. 4: Negative - The amount outstanding at the end of the accounting year alone should not be considered; each payment during the year must be evaluated.

The respondent was ordered to pay the applicant's costs.

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