9911796707
TMI Blog1980 (12) TMI 126X X X X Extracts X X X X X X X X Extracts X X X X ..... eral Insurance Co. Ltd. v. CIT [1979] 117 ITR 534 (Mad.) as concluding this question. In this decision, this court considered the scope of rule 1, Second Schedule, to the Companies (Profits) Surtax Act, 1964. Since the assessee, in that case, was an insurance company, the argument on behalf of the revenue based on Expln. II to rule 1 was not considered and no definite answer was given. In the present case, since the assessee is not an insurance company, the computation of the capital will have to be done with reference to the Explanation. Though the Full Bench decision related to an insurance company, as if the principle laid down in that judgment was applicable even to non-insurance companies, a Division Bench, without going into the Explanation, simply purported to apply the principle in the decision in India Motor Parts Accessories Ltd. v. CIT [1981] 130 ITR 311 (Mad.). It may also be mentioned that there was an earlier Bench judgment in Madras Auto Service v. CIT [1978] 112 ITR 540 (Mad.), which held that a provision for dividends cannot be considered to be a general reserve either on principle or on the provisions of the Companies Act. But this decision was ne ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sideration. In view of this, the Full Bench referred this case to a Fuller Bench by an order dated 1st December, 1980. That is how the case has come up for disposal before this Bench. The Income-tax Appellate Tribunal, Madras Bench "B", under section 18 of the C. (P.) S.T. Act, 1964, read with section 256(1) of the I.T. Act, 1961, referred the following question for the opinion of this court: "Whether, on the facts and in the circumstances of the case, Rs. 18,64,065, which was distributed as dividend to the shareholders of the assessee-company should be excluded in the computation of the capital for ascertaining the 'statutory deduction' for the purpose of assessment under the Companies (Profits) Surtax Act, 1964, for the assessment year 1970-71?" The assessee is a private limited company carrying on the business of passenger and goods transport. It filed its return showing a deficit of chargeable profits under the C. (P.) S.T. Act, 1964, hereinafter referred to as "the Act", for the assessment year 1970-71. The Surtax Officer, by his order dated 24th February, 1971, determined the taxable profits as Rs. 3,33,973 and levied a surtax of Rs. 83,493. In doing so, he computed the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... roved of this at the meeting held on September 30, 1969, the said amount could not be considered as capital for the purpose of computation of the "statutory deduction". The AAC did not accept this contention. He rejected the contention of the Surtax Officer that when the general body of the assessee-company sanctioned the distribution of Rs. 18,64,065 as dividend at the meeting held on September 30, 1969, the said sanction related back to the first day of the accounting year. It is against this reasoning and conclusion of the AAC that the department preferred an appeal to the Tribunal. The only contention raised by the department in the appeal before the Tribunal was that the sum of Rs. 18,64,065 being the amount distributed as dividend could not be taken as reserve and, hence, it should not be included for the computation of capital for the ascertainment of the "statutory deduction". The basis of the contention was that when the general body approved the recommendations made by the board of directors for the distribution of the dividend at the meeting held on September 30, 1969, the approval related back to the first day of the accounting year in view of the decision of the Supr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent, of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of two hundred thousand rupees, whichever is greater : " There are two provisos to this definition, which it is unnecessary to refer to for the purpose of this case. Section 4 of the Act is the charging section and the same reads as follows : "Subject to the provisions contained in this Act, there shall be charged on every company for every assessment year commencing on and from the first day of April, 1964, a tax (in this Act referred to as the surtax) in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third Schedule". Rule 1 of the Second Schedule, referred to in section 2(8) of the Act, so far as the same is relevant, as it stood at the relevant time, reads as follows : "1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of ( i )its paid-up share capital; ( ii )its reserves ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said Act deals with the obligation of the directors to file the copies of balance-sheet and profit and loss account before the Registrar of Companies, after the same have been laid before the annual general meeting of the company. Sub-section (2) of section 220 states that if the annual general meeting of a company before which a balance-sheet is laid as aforesaid does not adopt the balance-sheet, a statement to that effect and of the reasons therefor shall be annexed to the balance-sheet and to the copies thereof required to be filed with the Registrar. Against the above facts and the background of the statutory provisions, we shall now consider the question referred to this court, without reference to any decided cases. Section 217(1) of the Companies Act makes it clear that when the balance-sheet accompanied by a report of the board of directors, containing the allocation of certain amount towards reserves out of the surplus profits, is placed before the company in a general meeting, the board of directors is merely proposing that figure as the amount to be kept as reserve. Similarly when, in its report, the board of directors recommends a particular amount to be paid by way ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ral body meeting first approved the proposal of the board of directors to create a reserve of Rs. 25,45,923 and thereafter approved the recommendation of the board of directors to declare a dividend of Rs. 18,64,065. On the other hand, it will be in accordance with not only the letter but also the spirit of the law that the action of the company in its general meeting in approving the creation of a reserve as well as the recommendation for declaring dividend is one only and consequently the creation of a reserve and the declaration of dividend takes place simultaneously with the result that as far as the creation of a reserve is concerned, what springs from the action of the company at its general body meeting is the creation of a reserve of Rs. 6,81,858 only. The further contention of Mr. Swaminathan, learned counsel for the assessee-company, is that under art. 107 of the articles of association of the assessee-company, the board of directors had the authority to set aside and transfer to the reserve fund such sum as it thought proper out of the profits of the company, that for the accounting year in question the assessee-company had made a surplus profit of Rs. 78,95,923, that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to which the profits of the company may be properly applied, including provision for meeting contingencies or for equalising dividends; and pending such application, may, at the like discretion, either be employed in the business of the company or be invested in such investments (other than shares of the company) as the board may, from time to time, think fit. (2) The board may also carry forward any profits which it may think prudent not to divide, without setting them aside as a reserve". Section 9 of the Companies Act, 1956, reads as follows : "9. Save as otherwise expressly provided in the Act ( a ) the provisions of this Act shall have effect notwithstanding any thing to the contrary contained in the memorandum or articles of a company, or in any agreement executed by it, or in any resolution passed by the company in general meeting or by its board of directors, whether the same be registered, executed or passed, as the case may be, before or after the commencement of this Act; and ( b ) any provision contained in the memorandum, articles, agreement or resolution aforesaid, shall, to the extent to which it is repugnant to the provisions of this Act, become or be voi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1, 1969, and signing the same, it will not be referable to or relate back to 1st April, 1969, the first day of the previous year relevant to the assessment year 1970-71. On the other hand, it is the case of the assessee-company that by reason of the judgment of the Supreme Court in CIT v. Mysore Electrical Industries Ltd, [1971] 80 ITR 566 (to which we shall ourselves refer later in the course of the judgment), the "creation" of the reserve on August 30, 1969, will relate back to 1st April, 1969. If so, the question being not one of form, but of substance, the general reserve that was created as a result of the action of the company in its general meeting held on September 30, 1969, was the general reserve of Rs. 6,81,858 only and naturally that will relate back to 1st April, 1969. It is not the particular form that is adopted or the particular procedure that is followed which will determine the real nature of a transaction. In fact, no amount of ingenuity or jugglery in the procedure followed can conceal the real nature of a transaction. Logically speaking, out of the surplus profits, the amount recommended to be paid to the shareholders by way of dividend must be first set ap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s contained in the Act and the Companies Act, 1956. Even for the conclusion which we have reached, namely, that having regard to the language of section 217(1)( b ) of the Companies Act, 1956, a reserve is created only by the general body at its meeting, we find support in the decision of the Bombay High Court in CIT v. Aryodaya Ginning and Manufacturing Co. Ltd. [1957] 31 ITR 145 (Bom.), which was referred to with approval by the Supreme Court in CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566. In CIT v. Aryodaya Ginning and Manufacturing Co. Ltd. [1957] 31 ITR 145 (Bom.), the assessee was a limited liability company. The company made up its accounts at the end of December every year. For the year ending 31st December, 1948, the directors made certain appropriation of the profits of that year and the profits brought forward from the previous year and allocated certain amounts to the reserve fund and dividend reserve fund. At a general meeting held on June 27, 1949, the company accepted the recommendation of the directors and adopted the balance-sheet. In the assessment of the company to the business profits tax for the chargeable accounting period January 1, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1st December, 1948, and the reserves that should be constituted and shown in the balance-sheet as of the 31st December, 1948. When we look at the balance-sheet of the year ended on 31st December, 1948, these amounts are shown respectively in the reserve fund and the dividend reserve fund. Therefore, the shareholders by passing a resolution on the 27th June, 1949, did not decide that these amounts should constitute reserves as from that date, but they accepted the recommendation of the directors that these amounts should constitute reserves of the company as of the 31st December, 1948". After the above observation, there follows the following paragraph, which is of immediate relevance to the point which we have just dealt with (p. 151): "The Advocate-General says that there must be someone with the requisite authority who can decide that a certain amount should constitute reserve. The directors under the Companies Act do not have the requisite authority, only the shareholders have it, and till somebody has decided to this effect no part of the profits can become reserves. Now, that proposition is perfectly sound, but in advancing that argument what is overlooked is that the body ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntire sum of Rs. 25,45,923 is "reserve" within the scope of rule 1( iii ) of the Second Schedule to the Act, yet by the operation of the Explanation to that rule, the sum of Rs. 18,64,065 recommended for declaration of dividend will cease to be part of that reserve. It was not disputed before us that the sum of Rs. 18,64,065 came out of the sum of Rs. 25,45,923 shown as "reserve" in the balance-sheet signed by the directors on August 30, 1969. We have already extracted the Explanation to rule 1 of the Second Schedule to the Act. That Explanation makes it clear that for the purpose of computation of the capital of a company under the provisions of the Second Schedule, certain amounts standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which are of the nature mentioned in the Explanation shall not be regarded as a reserve. The Explanation refers to item (5) or item (6) or item (7) under the heading "Reserves and Surplus" or of any item under the heading "Current Liabilities and Provisions" in the column relating to "Liabilities" in the "Form of Balance-sheet" given in Pt. I of Schedule VI t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e board of directors have not shown the amount of proposed dividend in the balance-sheet itself, the question for consideration is, what is the legal consequence. In order to meet such contingency, the Explanation to rule 1 of the Second Schedule to the Act takes care to say "any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5)......or of any item under the heading 'Current Liabilities and Provisions'". The Explanation deliberately does not say, "any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year, which is an item under the heading 'Current Liabilities and Provisions'". The use of the expression, "of the nature" occurring in the Explanation is significant. In this particular case, if the balance-sheet was prepared by the assessee-company in the form of balance-sheet given in Pt. I of Schedule VI to the Companies Act, 1956, the board of directors should have shown the sum of Rs. 18,64,065 as item 9 under the heading "Current Liabilities and Provisions". ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 1957, and as to what constituted a debt for the purpose of ascertaining the net wealth. The Supreme Court observed (p. 772): "The second question does not call for a detailed scrutiny. Under section 2( m ) of the Wealth-tax Act, 'net wealth' means the amount by which the aggregate value computed in accordance with the provisions of the said Act of all the assets of the assessee on the valuation date is in excess of the aggregate value of all the debts owed by the assessee on the said date. The directors of the assessee-company showed in the profit and loss account a sum of Rs. 15,29,855 as the amount of dividend proposed to be distributed for the year ending March 31, 1957; but the said dividend was declared by the company at its general body meeting only on November 27, 1957. The question is whether the amount set apart as dividend by the directors was a debt owed by the company on the valuation date. The directors cannot distribute dividends but they can only recommend to the general body of the company the quantum of dividend to be distributed. Under section 217 of the Indian Companies Act, there shall be attached to every balance-sheet laid before a company in general mee ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the first day of the previous year", that is, the 1st April, 1963, in terms of rule 1 of the Second. Schedule to the Act and that these could only be taken into consideration in the subsequent year commencing on 1st April, 1964, on the ground that on 1st April, 1963, they only formed a part of the mass of undistributed profits, no portion of which had been earmarked or set apart for any particular purpose. The Supreme Court, after extracting rule 1 of the Second Schedule to the Act, rejected this contention. The Supreme Court observed (p. 569): "It is well known that the accounts of the company have to be made up for a year up to a particular day. In this case that day was the 31st March, 1963. If it was reasonably practicable to make up the accounts up to the 31st March, 1963, and present the same to the directors of the respondent on April 1, 1963, they could have made up their minds on that day and declared their intention of appropriating the said and other sums to reserves of different kinds. But the fact that they could not do so for the simple reason that the calculation and collection of figures of all the items of income and expenditure of the company for the year end ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ur opinion, the fact that the declaration of dividend creates a liability on the part of the company towards its shareholders does not in any way affect the question. By holding that the declaration of dividend will relate back to the 1st day of April, the court is not affecting the rights and liabilities between the company and its shareholders with reference to the dividend. It is merely adopting a practical and common-sense approach for the purpose of computation of the capital under the Second Schedule to the Act, and any such relation back will not affect the inter se rights and obligations between the company and its shareholders. This conclusion of ours is independent of the conclusion we have already reached, namely, that the creation of a reserve and declaration of dividend take place simultaneously and, therefore, the real reserve is the surplus profits proposed to be taken to the reserve by the board of directors minus the amounts recommended by the board of directors for declaration of dividend. As far as this court is concerned, there are two direct decisions dealing with the question. One is Nagammal Mills Ltd. v. CIT [1974] 94 ITR 387 (Mad.). In that case, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ken by the Tribunal that the appropriation came to be made subsequent to the first day of the previous year and, therefore, it should be taken that on the relevant date the profits have not been appropriated for any particular purpose cannot, therefore, be accepted. Though the appropriation came to be actually made by the company on November 12, 1961, it should be deemed to relate back to the first day of the previous year". With regard to the sum of Rs. 3,43,485 set apart for payment of dividend, this court observed (p. 391 of 94 ITR): "Coming to the provision for dividend of Rs. 3,43,485 it is seen that the said dividend has actually been paid out by the company to its shareholders. Though the same was set apart for a specified purpose, it cannot be said to be available for the future use of the company so as to partake the character of capital. The said sum set apart for payment towards a specific liability cannot be said to be a reserve for future use of the company. This sum, has, therefore, to be treated as not a reserve". The second decision is Madras Auto Service v. CIT [1978] 112 ITR 540 (Mad.). In the said decision, which was rendered by two of us (Ismail J., as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the Companies Act is actually referred to in the Explanation to rule 1 under the Second Schedule to the Companies (Profits) Surtax Act, 1964". The next decision is that of the Bombay High Court in CIT v. Bharat Bijlee Ltd. [1977] 107 ITR 30. The two questions which the Bombay High Court had to consider in the said decision were : "1. Whether, on the facts and in the circumstances of the case, the dividend reserve was a reserve includible in the computation of capital of the assessee-company as contemplated under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964? 2. If the answer to question No. 1 is in the affirmative, whether the dividend reserve includible in the computation of capital of the assessee-company as on July 1, 1964, was in the amount of Rs. 5,90,000 or in the amount of Rs. 3,60,000?" In that case, the balance-sheet of the company for the year ending June 30, 1964, showed an item of dividend reserve under the head "Reserves and surplus". The relevant part of the balance-sheet was as under: " Reserves and surplus Rs. Rs. Dividend reserve : as per last account ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... before the High Court that as a sum of Rs. 1,55,000 was already standing to the credit of the dividend reserve account, only a sum of Rs. 75,000 should be treated as being available from the current profits for payment of the sum of Rs. 2,30,000 as proposed dividend and, therefore, a sum of Rs. 5,15,000 should be regarded as includible in the computation of capital for the purpose of surtax. The High Court rejected this contention. The High Court pointed out thus (pp. 34, 35) : "For the year ending June 30, 1964, the directors had recommended an aggregate amount of Rs. 2,30,000. No independent provision was made for payment of this amount but it was stated in the report that the said amount will be paid out of the dividend reserve. Out of the profits or income for the year ending June, 30, 1964, a sum of Rs. 4,35,000 was directed to be appropriated towards the dividend reserve account. Thus, the whole of the sum of Rs. 2,30,000 could come out of the said amount and the balance will be credited to the dividend reserve account so as to be added to the amount of Rs. 1,55,000 already standing to the credit of the dividend reserve account. From the commercial point of view if any amou ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of capital had to be made as on June 1, 1968. The balance-sheet of the company as on May 31, 1968, showed that in the item, general reserve, under the heading "Reserves and Surplus" initially at the beginning of that year there was a balance of Rs. 4,81,501. Out of the profits during the year ending May 31, 1968, the sum of Rs. 2,44,000 was directed to be appropriated by transfer to general reserve. In the same year, that is, May 31, 1968, the directors recommended that the sum of Rs. 2,10,000 should be paid as final dividend, if approved by the shareholders at the annual general meeting to be held on September 30, 1968, and the same should be paid out of the general reserve. The question that arose was, whether the said sum of Rs. 2,10,000 forming part of the general reserve was includible in the capital of the company for the purpose of surtax. For the assessment year 1971-72, the relevant date for computation of the capital was December 1, 1969. The position shown by the balance-sheet as on November 30, 1969, was that at the beginning of that year a sum of Rs. 5,15,501 was standing to the credit of the general reserve. Out of the profits of 18 months ending on November 30, 1969, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es of the case, the general reserve to the extent of Rs. 18,35,715 as on July 1, 1964, was includible in the computation of capital of the assessee-company under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, for the assessment year 1966-67?" The court pointed out that so far as the reference was concerned, the facts need not be stated because the principles on the basis of which the questions were to be answered had been fully laid down in more than one decision of that court decided that day and a few days earlier. The court stated: "For the assessment year 1965-66, the crucial date is July 1, 1963. It is clear from the balance-sheet and profit and loss account for the year ending June 30, 1963, that the sum of Rs. 17,25,000 is appropriated from the current profits to the dividend reserve account and out of that the sum of Rs. 17,15,715 is directed to be paid as dividend in the same year. Thus, the sum of Rs. 17,15,715 which is the proposed dividend will not be includible in the computation of capital and only the balance of Rs. 9,285 will be treated as capital for the purpose of the Surtax Act. Therefore, our answer to question No. 1 is that out o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... inding". The court referred to the decisions of the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53; 39 Comp. Cas. 410, Purshottamdas Thakurdas v. CIT [1963] 48 ITR (SC) 206 and CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566, and considered the distinction between the conceptions of "provision" and "reserve". The court pointed out that when there was no liability on the last day of the year, the question of making a provision would not arise. The court also referred to its earlier decision in CIT v. Aryodaya Ginning and Manufacturing Co. Ltd. [1957] 31 ITR 145, already referred to, and pointed out (pp. 795, 796 of 107 ITR): "This decision of this High Court cannot be attracted for application to the facts of the present case, because in the present case no amount whatsoever has been set apart even for dividend reserve. Actually, except for a bare recommendation in the directors' report for declaration of dividend, no amount is set apart for payment of the said amount. In such a case, if and when the shareholders decide at an annual general meeting to declare dividend, the dividend shall have to be paid out of the ge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Kantawala C.J. and Tulzapurkar J., as he then was, who rendered the decision in CIT v. Bharat Bijlee Ltd. [1977] 107 ITR 30 (Bom.) on July 28 and 29, 1976 and the decision in CIT v. Marrior ( India ) Ltd. [1977] 107 ITR 35 (Bom.) on July 29, 1976, and the decision in CIT v. Hindustan Sugar Mills Ltd. [1977] 107 ITR 659 on July 29, 1976, and, therefore, it cannot be assumed that the learned judges were contradicting themselves and in the later three decisions they took a view different from the one which they had taken in this decision rendered on June 18, 1976, without even referring to the same in their later decisions. The decision of the Gujarat High Court relied on by the learned counsel for the assessee-company, as already stated, is CIT v. Mafatlal Chandu Lal Co. Ltd. [1977] 107 ITR 489. In that case, the following two questions were referred to the court: "1. Whether, on the facts and in the circumstances of the case, the sum of Rs. 3,31,069 standing in the provision for taxation account on December 31, 1961, was includible in computing the capital of the company for the purposes of the Super Profits Tax Act, 1963? 2. Whether, on the facts and in th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pt apart for future use or for a specific occasion. The accounting practice followed by the company has to be taken into account and the requirement of statute which the assessee-company is required to follow have also to be borne in mind. It is because of this account-keeping practice that the statute imposes upon the assessee-company under the Indian Companies Act, 1956, particularly the form of the balance-sheet, that this distinction between 'provision' and 'reserve' also becomes material for the purpose of finding out what exactly constitutes 'reserve' under rule 1 of Schedule II to the Act of 1963. It is true that though the Indian Companies Act was in force when the Act of 1963 was enacted, there is no reference in the definition section to the Companies Act, 1956, but in view of the decision of the Supreme Court in Standard Vacuum Oil Company's case [1966] 59 ITR 685 (SC), it is really not necessary that there should have been any such reference in the definition section because the requirement of the statute which the company is required to follow in its account-keeping practice have to be taken into consideration while considering this question of reserve". (Underlining ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Depreciation fund 2,25,000 0 0 Towards provision for income-tax, corporation tax and business profits tax 12,50,000 0 0 To Reserve fund 11,08,000 0 0 To Dividend reserve fund 1,50,000 0 0 To Dividend payments 67,812 8 0 To Charity account 5,000 0 0 To carry forward to next year's account 89,134 1 11" From the above, it will be clear that there were two appropriations, one to "dividend reserve fund" and the other to "dividend payments". The items that were the subject-matter of controversy were only three, namely: (1) the sum of Rs. 12,50,000 set apart towards provision for income-tax, corporation tax and business profits tax; (2) the sum of Rs. 11,08,000 set apart towards "reserve fund"; and (3) the sum of Rs. 1,50,000 set apart towards "dividend reserve fund". There was no controversy with regard to the sum of Rs. 67,812-8-0 set apart towards "dividend payments". The judgment points out (p. 149): "The company's contention was that the paid-up capital should be increased by the amount of reser ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al Mills Ltd. [1977] 108 ITR 236 considered the distinction between "provision" and "reserve" according to the principles of accountancy and statutory provisions and held that an appropriation towards "dividend equalisation reserve" is a "reserve" and not a "provision". We are merely referring to this only for the purpose of emphasising the difference between the amount set apart towards "dividend reserve fund" and the amount set apart towards "payment of the proposed dividend". Further, the Gujarat High Court in the decision in question, namely, CIT v. Mafatlal Chandulal Co. [1977] 107 ITR 489 had not given full effect to the decision of the Supreme Court in Mysore Electrical Industries Ltd.'s case [1971] 80 ITR 566. The Supreme Court had held that when the resolution of the general body meeting creating a reserve out of the profits of a company for the concerned year will relate back to the first day of the succeeding year, there is no justification on principle for holding that the resolution of the same general body meeting of the company regarding declaration of dividend will not have such an effect. As we have pointed out already, the fact that the reserve will rem ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fore, the subsequent recommendation of the board of directors to pay dividends to the shareholders to the tune of Rs. 4,00,000 and the subsequent endorsement by the general body of shareholders would not have any effect of dating back the dividends to the date of the preparation of the balance-sheet. Indeed there was no indication of any appropriation in the balance-sheet. In such a case how could there be relating back to something which was not even in any embryonic form? I, therefore, hold that the subsequent declaration of dividends from out of the general reserve cannot be related back to the date of the balance-sheet. The true nature and character of the entry in the balance-sheet is patently one of 'reserve' and not of 'provision'. The amount of general reserve, not to speak of the later declaration of a sum of Rs. 4,00,000 towards dividends from out of the general reserve, was not set apart to meet any liability, contingency, commitment or diminution in value of assets known to exist at the time of the balance-sheet. The board of directors and the general body of the shareholders may or may not declare any dividends. As on the date of the balance-sheet there was no known li ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... case, the Tribunal, whose decision was reversed by the High Court, followed an earlier decision of the Andhra Pradesh High Court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1974] 96 ITR 248. The Andhra Pradesh High Court in Super Spinning Mills Ltd. v. CIT [1979] 120 ITR 512 referred to the said decision in Vazir Sultan Tobacco Co. Ltd.'s case [1974] 96 ITR 248 (AP) and tried to distinguish the same. The relevant portion of the judgment dealing with Vazir Sultan Tobacco Co. Ltd.'s case [1974] 96 ITR 248 (AP) is as follows (p. 520 of 120 ITR): "This court considered the question at some length in Vazir Sultan Tobacco Co. Ltd. v. CIT [1974] 96 ITR 248 (AP). It was a case which arose under the Super Profits Tax Act of 1963, and the question was that the provisions of certain amounts, (1) for taxation, (2) for retirement gratuity, and (3) for dividends, should be considered as 'reserves' within the meaning of Schedule II to the S.P.T. Act, so that they could be considered for determination of the company's capital. The learned judges held that the amount set apart for tax liability was a 'provision' and not a 'reserve' because it was set apart to meet a known liability, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rd to the dividend of Rs. 18,41,820 mentioned in the question (p. 260): "Then we come to the amount set apart for dividends. The directors of the assessee-company had recommended the payment of that amount as dividends. It has not been shown that the directors have rescinded their recommendation to pay it as dividends. Subsequent events may prove that the recommendation of the directors may be ratified by the shareholders. In such an event, the shareholders would be entitled to enforce the payment of the dividends against the company. Since, however, the liability to pay the dividends was existing on the date of the balance-sheet, and the amount has been set apart specifically for the payment of dividends, it is, in our opinion, a 'provision' and not a 'reserve' ". However, the High Court of Andhra Pradesh in Super Spinning Mills' case [1979] 120 ITR 512 itself stated that the correctness of the decision in Vazir Sultan Tobacco's case [1974] 96 ITR 248 (AP) was doubted and consequently another Division Bench referred the problem to a Full Bench and the Full Bench of the Andhra Pradesh High Court in Hyderabad Asbestos Cement Products Ltd. v. CIT [1976] 105 ITR 822 resolv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... liability, the quantum of which, on that date, cannot be determined with substantial accuracy.' What Mr. Srinivasamurthy contends is that the principle set out above, within quotes, is not supported by the decision of the Supreme Court in Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax [1966] 59 ITR 767. However, on closer examination, we noticed that the reference to Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax [1966] 59 ITR 767 (SC) was really a mistake and that the court was really referring to the case of Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC). This is evident from the fact that the language and the expressions used in the said paragraph are the same which are employed in the case of Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53 (SC). In fact, the words 'substantial accuracy' are taken from the decision of the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53 and that the said expression does not occur in the case of Kesoram Industries and Cotton Mills Ltd. v. Commissioner of Wealth-tax [1966] 59 ITR 767 (SC). We presume ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vision for taxation and proposed dividends, respectively, did not fall under rule 2( i ) of the Second Schedule to the Companies (Profits) Surtax Act, 1964? Assessment year 1966-67: Whether, on the facts and in the circumstances of the case, it has been rightly held that the sums of Rs. 3,34,756, Rs. 1,70,463, Rs. 41,36,469, Rs. 17,21,932, Rs. 8,00,000 and Rs. 82,333 representing the premium deposits, unearned premium, provision for outstanding claims, provision for taxation, proposed dividends and balance in the profit and loss account, respectively, did not fall under rule 2( i ) or rule 2( ii ) of the Second Schedule to the Companies (Profits) Surtax Act, 1964? Assessment year 1967-68 : Whether, on the facts and in the circumstances of the case, it has been rightly held that the sums of Rs. 93,250, Rs. 2,25,067, Rs. 25,17,281, Rs. 13,97,886, Rs. 7,48,110 and Rs. 7,071 representing the premium deposits, unearned premium, provision for outstanding claims, provision for taxation, proposed dividends and balance in the profit and loss account, respectively, did not fall under rule 2( i ) or rule 2( ii ) of the Second Schedule to the Companies (Profits) Surtax Act, 1964?" Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r the purpose of rule 1 of the Second Schedule. On the basis of this provision in rule 2 of the Second Schedule, the assessee has contended that the following amounts shown in the balance-sheet at page 18, namely, Rs. 24,36,239 under the heading 'Reserves or Contingency Accounts', the sums of Rs. 1,82,346, Rs. 50,709 and Rs. 16,70,197 falling under 'Estimated liability in respect of outstanding claims whether due or intimated' which amounts sum up to Rs. 19,03,352 as also the provision towards unearned premium and premium deposits of the amounts, Rs. 2,40,197 and Rs. 91,510, as seen at page 20 of the balance-sheet falling under the heading 'Liabilities' as well as the sum of Rs. 6,42,524 which is termed as 'Proposed dividend for the year 1964' should be deducted from the value of the assets, the income from which is required to be excluded for the purpose of rule 1 of the First Schedule in order to arrive at the capital base or the value of the capital assets in relation to which 10% has to be allowed as a statutory reduction". The court thereafter dealt with those items one by one and with regard to the item under the heading 'Proposed dividend for the year 1964' it observed (p. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was submitted that if appropriation to reserves has been made by the general body it will date back to the first day of the year in question, because it must be taken to be a reserve made on the first day of the year in question. This decision only dealt with the reserves which were for purposes other than the reserves for the purpose of payment of dividends. Therefore, this decision cannot be taken as an authority for the proposition that an appropriation made towards the reserve for the purpose of payment of dividend, apart from making the appropriation later effective from the first day of the year of account, will also create a liability for dividend from the first day of the year of account". (underlining is ours). With great respect to the learned judges, we are unable to share their view. In the context in which we are considering the question, there cannot be an accrued liability for payment of dividend on the first day of the year. As a matter of fact, as we have pointed out already, on the first day of the year following the year of account, there may not be any scope even for finding out whether the company has made a profit or suffered a loss and, consequently, th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dividend, and the decision in Kesoram Industries and Cotton Mills Ltd. v. CWT [1966] 59 ITR 767 (SC), which specifically dealt with the question of reserves for dividend, which on the date of valuation, were only in the nature of proposal for payment of dividend, will have to be noticed and applied. If we have to reconcile the two decisions, which dealt with different kinds of reserves, we have to come to the conclusion that the amounts in question are reserves that have been made for payment of dividend at the time when there was only a proposal made by the directors and, though they have been shown in the balance-sheet as a separate item indicating a specific sum under the heading 'Proposal for dividend', nevertheless remains as a provision for reserve made for the purpose of meeting the contingent liability which may or may not accrue depending upon the shareholders approving of that proposal of the directors or not". With respect to the learned judges, we are unable to share either their reasoning or the assumption underlying their reasoning. In our opinion, the expression, "If we have to reconcile the two decisions" is not warranted because, as we have pointed out alread ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd, and the decision in Kesoram Industries and Cotton Mills Ltd. v. CWT [1966] 59 ITR 767 (SC), which specifically dealt with the question of reserves for dividend, which on the date of valuation, were only in the nature of proposal for payment of dividend, will have to be noticed and applied. If we have to reconcile the two decisions, which dealt with different kinds of reserves, we have to come to the conclusion that the amounts in question are reserves that have been made for payment of dividend at the time when there was only a proposal made by the directors and, though they have been shown in the balance-sheet as a separate item indicating a specific sum under the heading 'Proposal for dividend', nevertheless remains as a provision for reserve made for the purpose of meeting the contingent liability which may or may not accrue depending upon the shareholders approving of that proposal of the directors or not". With respect to the learned judges, we are unable to share either their reasoning or the assumption underlying their reasoning. In our opinion, the expression, "If we have to reconcile the two decisions" is not warranted because, as we have pointed out already, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gment under consideration. We think, therefore, that the decision cannot be taken to be a precedent for the question which has to be dealt with in this judgment, but can be distinguished, as we propose to do, as a case where the emphasis had been on the payment out of the money which was at one time provided for dividend and in view of the fact that the proposal of the directors was later approved by the shareholders of the company and the money had been actually expended for the purpose. We are not called upon in this case to consider whether payment out during the year of account will deprive the right of an assessee to claim the benefit, for, that question does not arise before us, no point having been taken in that behalf. We, therefore, leave that question open to be considered in another appropriate case". With respect to the learned judges, we are clearly of the opinion that the conception of accrued liability as on the first day of the year of account can have no reality or relevancy to the point under consideration under rule 1( iii ) of the Second Schedule to the Act. As we have pointed out more than once, rule 1 of the Second Schedule to the Act does not refer either e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... again that there is a distinction between a provision for an uncertain and unaccrued liability and a reserve made for meeting any contingent liability we think that it will be a reserve that will fall under rule 1 of the Second Schedule. If the amount will fall under rule 1 of the Second Schedule then the amount cannot be excluded for the purpose of sub-rule ( ii ) of rule 2 and, therefore, the assessee has in any case to fail on this aspect as well". Thus, it will be seen that the ultimate decision of the Full Bench was based upon what it considered to be the effect of sub-rule ( ii ) of rule 2 of the Second Schedule on the assumption that the amount was a "reserve". Consequently, there was no need for the Full Bench to really decide whether the concerned amount was a reserve or not, because even on that assumption the assessee had to fail. However, we may make it clear that if the Full Bench intended to lay down a proposition that even if the board of directors set apart a specific sum under the heading "Proposal for dividend" and, subsequently, the company in its general body meeting accepted their proposal and declared the said amount as dividend, still the same would contin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny the computation of capital will have to be done with reference to the Explanation. Though the Full Bench decision related to an insurance company, as if the principle laid down in that judgment was applicable even to non-insurance companies, a Division Bench, without going into the Explanation, simply purported to apply the principle in the decision in India Motor Parts Accessories Ltd. v. CIT [1981] 130 1TR 611". We are of the opinion that the construction of the relevant provision in rule 1 of the Second Schedule to the Act is not dependent upon whether the company is an insurance company or not, because there is nothing in that particular rule which is exclusively applicable cither to an insurance company or to a non-insurance company. Further, a perusal of the Act does not show that there is any Explanation as Explanation II to rule 1 of the Second Schedule to the Act and the same may be a typographical error. Under these circumstances, we answer the question referred to this court in the affirmative and against the assessee. The respondent-Commissioner is entitled to his costs of this reference and the counsel's fee is fixed at Rs. 1,000 (Rs. one thousand ..... X X X X Extracts X X X X X X X X Extracts X X X X
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