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TMI Blog1962 (1) TMI 82X X X X Extracts X X X X X X X X Extracts X X X X ..... lus" can be treated as a "reserve" within the meaning of the Act. The Business Profits Tax Act (hereinafter referred to as the Act) , which came into force on April 11, 1947, had for its object the imposition of a special tax on income arising from business by reason of the abnormal profits made in consequence of the war. This tax was over and above the levy under the Indian Income-tax Act, 1922. The Act, however, was not made to apply to the whole of the profits made in a business and a part of it was allowed to be left out of account in the computation of profits for its purposes. This was done by providing "abatement", namely, a sum which bore to a sum equal to, in the case of a company like the assessee, six per cent. of its capital on the first day of any "chargeable accounting period" computed in accordance with Schedule II or one lakh of rupees whichever was greater. The capital, however, was not limited to the paid up capital but was also to include certain reserves and any premium realised by a company from the issue of any of its shares and retained in the business. The life of the Act came to an end on March 31, 1949. Under section 2( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntended that the excess of the value of the assets taken over the paid up capital of the company has always been treated as a reserve and has never been allowed in computing the profits of the company for the purposes of the Indian Income-tax Act and hence the same is to be taken into account for computing its capital. The chargeable accounting periods with which we are concerned in this case are five, they extend from : (1) 1-4-1946 to 30-11-1946 (2) 1-12-1946 to 31-3-1947 (3) 1-4-1947 to 31-12-1947 (4) 1-1-1948 to 31-12-1948 (5) 1-1-1949 to 31-3-1949. For all these accounting periods the "capital paid in surplus" remained the same. The earned surplus has varied from time to time but it has always gone on increasing and is said to represent that part of the profits of the assessee which has been set apart after the distribution of dividends. The facts relating to the accounts of the company are as follows : The assessee is a non-resident company. It was incorporated in the State of Delaware in U.S.A. with a capital of $10,000,000 divided into 1,00,000 shares of the par value of $ 100 each. The object of incorporation was to take over all the assets and liab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et value of the assets transferred and the face value of the shares together with the par value of the serial bonds allotted to Soconey Vacuum Corporation was represented by the figure $ 117,561,317. Both the vendor companies disclosed in their books of account, as the cost of the respective investments in the shares of the assessee company, the value of the assets which they transferred to the assessee company. In all assessment proceedings for the purpose of depreciation, the value of the aforesaid assets was taken at cost. A summary of the consolidated world balance-sheet of the assessee as on December 31, 1945, taken from the statement of case is given below: Consolidated Balance-Sheet at December 31, 1945. (Relevant for the chargeable accounting period from 1-4-1946 to 30-11-1946) . Assets Liabilities : Capital Stock & Surplus Current assets $ 143.376,559 Current liabilities $ 70,187,822 Govt. of India compulsory Excess Profits Tax Deposit (Recoverable) $ 1,755,597 Due to subsidiaries not consolidated $ 92,260 Due from Soconey Vacuum Oil Co. incorporated and Standard Oil Co. (New Jersey) Deferred credits Reserves Capital stock surplus Capital surplus paid i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lding of profits had not been specifically termed as reserves in the account of the company there was no doubt that the figures represented reserves which should be added to the paid-up capital under rule 2(1) of Schedule II to the Act. The Tribunal negatived the contention of the revenue that "earned surplus" merely represented the balance of the profit and loss account. The finding of the Tribunal is fortified by a comparison of the value of the fixed assets which went on rising from $69,000,000 in 1944 to $276,000,000 in 1952. The Income-tax Officer relied on the judgment of the Bombay High Court in CIT v. Century Spinning & Manufacturing Co. Ltd. [1951] 20 ITR 260, to negative the contention of the assessee that the "earned surplus" constituted a reserve. Before the Appellate Assistant Commissioner the assessee pointed out that in the American system of accounting the appropriations for the year are to be made during the year and even the dividend which is declared just after the close of the year is passed through the relevant earned surplus account which is termed as profit and loss account in India. The Appellate Assistant Commissioner recorded that surp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... treated as having been issued at a premium merely because the transaction leading to their issue actually resulted in a surplus to the company. Both the Income-tax Officer and the Appellate Assistant Commissioner were of the view that this amount could not be included as "reserves" as it had not been created out of the profits of the company within the meaning of rule 2 of Schedule II to the Act. They relied on the judgment of Chagla C. J. in the case of Century Spinning Mill's case (supra) . They further negatived the claim of the assessee with regard to the "earned surplus" on the basis of the said decision of the Bombay High Court, namely, that they had not been set apart or allocated as reserves. As already noted, the Tribunal however took a different view and the questions formulated by this court on the application of the Commissioner of Income-tax are as follows : "(1) Whether, on the facts found, the Tribunal was right in holding that the sum of $117,000,000 appearing in the balance-sheet of the assessee company under the head 'capital paid in surplus' and constituting the excess of the book value of the assets over the face value of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ry of the property and assets and of the capital and liabilities of the company in accordance with the requirements indicated by the heads contained in the Form marked "F" in the Third Schedule. Form "F" contains a head "reserve" under the heading "capital and liabilities". Regulation 99 of Table A empowered the directors to set aside out of the profits of the company such sums as they might think proper as reserve or reserves before recommending any dividend for the purpose of meeting contingencies or for equalising dividends or for any other purpose to which the profit of the company might be properly applied. "Premium", according to the dictionary, means a reward, a bonus, a bounty or something beyond the amount claimable. It was pointed out as early as in 1892 in Ooregum Gold Mining Co. of India Ltd. v. Roper [1892] AC 125, 136by Lord Watson that "a company is free to contract with an applicant for its shares ; and when he pays in cash the nominal amount of the shares allotted to him, the company may at once return the money in satisfaction of its legal indebtedness for goods supplied or services rendered by him. That cir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Reference was made to the observations of Clauson J. at page 403: "The premium from its very nature is not part of the capital paid up on the shares ; it is the surplus of the sum received in respect of the share over the amount required to pay up the share to the extent to which it is treated by the company as paid up" and it was argued that such surplus could only be in cash. In that case there was no question as to whether premium could take any other shape but from this it did not follow that the word "premium" could not be applied to a case where shares were issued for consideration other than cash. Until 1948, there was no statutory provision in England with regard to issue of shares at a premium. Section 56 of the English Companies Act, 1948, provided that, "where a company issues shares at a premium whether for cash or otherwise a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account to be called the ' share premium account' and the provisions of the Act relating to the reduction of the share capital of the company shall, except as provided in this section, apply as if the share premi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in such ways as it pleases and it may create any number of reserves. Thus, for instance, the reserves may take any of the following character: (1) Capital reserve including reserve for redemption of redeemable preference shares. (2) Reserve for redemption of debentures. (3) Reserve for replacement of plant and machinery. (4) Reserve for buying new plant to be added to the existing ones. (5) Reserve for bad and doubtful debts. (6) General Reserve. Other reserves may be created by companies for special purposes. Excepting the last, the above reserves are all earmarked for one or other purpose. In view, however, of the provisions of the Indian Income-tax Act, 1922, a company is not free to deal with the entire profits after meeting its expenses in any manner it likes but has to pay tax after deductions allowed under section 10 of the Act are taken into account. Section 10(2)(vi) of the Income-tax Act allows a company to set apart a portion of its profits to meet depreciation on buildings, machinery, plant or furniture, and any reserve which a company may wish to make in this respect will be taken into account in computing the profits for the purposes of the Indian Income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ares before the Act of 1922 came into force, the company can lawfully claim the same to be taken into account for the determination of the abatement. After the Indian Income-tax Act of 1922 came into force, it would be open to the company to create reserves out of allowable deductions under section 10(2) of the Indian Income-tax Act as well as out of net profits after payment of the tax. Rule 2(1) would exclude the first kind of reserves but not those of the second kind. Counsel for the revenue drew my attention to the observations of the Supreme Court in Commissioner of Income-tax v. Century Spinning and Manufacturing Co. Ltd. [1953] 24 ITR 499 ,503reading that "two essential characteristics must be present before the assessee can avail himself of the benefit of the rule, namely, that the amount should not have been allowed in computing the profits of the company for the purposes of the Income-tax Act and that it should be a reserve as contemplated by the rule. That it has not been so allowed is not denied and therefore the only question is whether it can be treated as a reserve within the meaning of the rule". It was argued that this dictum showed that the Supreme Cour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e-tax [1961] 42 ITR 17 the question was whether "undivided profits" shown in the balance-sheet of the bank could be treated as reserves "Undivided profits" of the bank, which was incorporated in the United States of America, were found by the Supreme Court to be equivalent to the unallocated amount carried forward at the end of the year of account in the balance of profit and loss account as known in India. This "undivided profits" had been ignored by the Income-tax Tribunal of Bombay for the purpose of determination of abatement under the Business Profits Tax Act. The Supreme Court held that the Tribunal had gone wrong in this finding and on the basis of a letter from the Deputy Controller of Currency, Washington, came to the conclusion that "the creation and maintenance of the item known as ' undivided profits' is a requirement of the Treasury Rules which are made under the statute and, therefore, it cannot be said that the amount of ' undivided profits ' in the balance-sheet was not allocated as a result of either a resolution of the directors accepted by the shareholders or on account of the requirements of the law". The S ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... noted that "the accumulated balance in the profit and loss account has actually been invested in the business and there is no regulation in the American Income-tax Act for setting apart any part of the profits in general reserve". He, however, went on to add "but it is an assessment under the Indian Act which provides that in order to get the benefit of capital the appellant must set apart the amount out of the profits to reserves" and he could not therefore accept the claim of the assessee. The Tribunal examined the table showing the earned surplus, the net profits, the appropriations made within the year, the earnings re-invested and the fixed assets placed before the Appellate Assistant Commissioner and noted at page 95 of the paper-book (reproduced earlier in this judgment) and came to the finding "that out of the profits of the two years ending November 30,1945, no appropriations were made. This means that the total sum of those two years' profits were retained in the business and were to that extent treated as reserves" The Tribunal went on to examine the figures for subsequent years up to December 31, 1948, and found that the appellant comp ..... X X X X Extracts X X X X X X X X Extracts X X X X
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