1968 (12) TMI 22 - HC - Income Tax

Contribution from Govt. and outside parties for capital expenditure - contention of the appellant-company that this amount should be taken as a reserve for the purpose of capital computation for business profits tax purposes - held that amounts entered in the books of the assessee as contribution from outside parties for capital expenditure must be treated as reserve

Summary

Issues Involved:
1. Whether the contributions from outside parties for capital expenditure constitute "reserves" under Schedule II, rule 2 of the Business Profits Tax Act.
2. Whether the investments referable to the contribution from employees can be deducted under Schedule II, rule 2, in the assessment for the chargeable accounting period ended March 31, 1947.

Issue-Wise Detailed Analysis:

1. Contributions from Outside Parties as "Reserves":
The primary issue was whether the sums of Rs. 9,56,838 and Rs. 10,15,242, received as contributions from outside parties for capital expenditure, and shown in the accounts with the narration "contribution from outside parties for capital expenditure," constitute "reserves" within the meaning of rule 2 of Schedule II of the Business Profits Tax Act.

The Business Profits Tax Officer and the Appellate Assistant Commissioner initially held that these amounts did not form part of the company's reserves, emphasizing that the amounts were received from outside parties for specific purposes and were not set apart by the company itself as reserves. They relied on the Supreme Court's definition of "reserve," which requires setting apart of amounts for specific or general purposes by authorized company personnel.

However, the Tribunal disagreed, holding that the absence of the nomenclature "reserve" did not preclude these items from being considered as reserves. The Tribunal followed the Calcutta High Court's decision in Commissioner of Income-tax v. Standard Vacuum Oil Co., which held that reserves need not necessarily arise out of profits.

The High Court affirmed the Tribunal's view, relying on the Supreme Court's decision in Commissioner of Income-tax v. Standard Vacuum Oil Co., which clarified that reserves under rule 2 need not necessarily arise out of profits. The Court emphasized that the term "reserve" in rule 2 should be interpreted broadly to include amounts set apart for future use or specific occasions, regardless of their source. Consequently, the contributions from outside parties were held to be reserves, thereby increasing the abatement and reducing the taxable profits.

2. Deduction of Investments Referable to Employee Contributions:
The second issue was whether the investments referable to the contribution from employees to the works provident fund could be deducted under Schedule II, rule 2, in the assessment for the chargeable accounting period ended March 31, 1947.

The Business Profits Tax Officer included the entire amount of investments representing the works provident fund account as investments by which the capital had to be diminished. The Appellate Assistant Commissioner affirmed this decision, stating that the rule speaks only of the company's investments without considering the source of these investments.

The Tribunal, however, held that only the employer's contribution to the works provident fund should be treated as a reserve, while the employees' contribution should not be considered as such since it was held in trust for the employees. Consequently, only the investments referable to the employer's contribution should be deducted.

The High Court agreed with the Tribunal, noting that the investments of the provident fund are mandated by law and are held in trust for the employees. The rule requires that the capital, including reserves, be diminished by the cost of investments. The Court concluded that only the proportionate amount of investments corresponding to the employer's contribution, which is treated as a reserve, should be deducted. This interpretation ensures that the rule retains its meaning and does not unduly burden the assessee.

Conclusion:
The High Court answered both questions in favor of the assessee. The contributions from outside parties for capital expenditure were held to be reserves within the meaning of rule 2 of Schedule II, thereby increasing the abatement and reducing the taxable profits. Additionally, only the investments referable to the employer's contribution to the works provident fund were to be deducted, ensuring a fair and proportionate application of the rule. The Commissioner was ordered to pay the costs of the assessee.