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TMI Blog1995 (12) TMI 22X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessment year 1974-75, the reserve had accumulated to Rs. 15,00,000. While completing the surtax assessment, the Income-tax Officer held that it is only a provision to meet a known liability and hence it is not a reserve to be includible in the capital base. On appeal, the Commissioner of Income-tax (Appeals) also agreed with the Income-tax Officer. In further appeal by the assessee, the Appellate Tribunal held that as per clause 20 of the debenture trust deed, the assessee was empowered to utilise the aforesaid amount for the purpose of its business and hence the money cannot be said to have been set apart to meet a known liability. The Tribunal, therefore, came to the conclusion that the debenture redemption reserve should be treated as a "reserve" for the purpose of capital computation. Learned standing counsel for the Department submitted that it is a provision made to meet a known liability. The debenture redemption reserve is in fact a reserve created to meet a liability, viz., the redemption of the debenture. In view of the decision of the Supreme Court in the case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53, the debenture redemption reserve is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d also provided for the creation of a reserve. The relevant clauses are as follows : " 19. The company shall create and maintain an account called debenture redemption reserve as from 31st March, 1971. The company will in the financial year 1970-71 (i.e., year commencing from 1st April, 1970, and ending with 31st March, 1971), and in every subsequent financial year thereafter till the financial year ending 31st March, 1977, transfer a sum of Rs. 5,00,000 per year to the debenture redemption reserve. Provided that if the company transfers to the debenture redemption reserve a sum of Rs. 5 lakhs in any financial year, such excess shall be adjusted in any subsequent year or years towards transfers to be made to the debenture redemption reserve, in such subsequent year or years. 20. The company shall be entitled to use the moneys standing to the credit of the debenture redemption reserve, for redemption of debentures as provided as clauses 4 and 5 hereof for the company's business purposes. " The Bombay High Court in CIT v. National Rayon Corporation Ltd. [1986] 160 ITR 716, while considering the nature of debenture redemption reserve held that, "a perusal of the balance-sheet of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... et as a liability. The debenture redemption reserve had not been converted into a sinking fund by investment. Therefore, the Tribunal was right in holding that the debentures redemption fund could not be excluded in computing the capital of the assessee for the purpose of surtax. " So also in the case of CIT v. National Rayon Corporation Ltd. [1992] 193 ITR 577 (Bom), the Bombay High Court held that, "the debenture redemption reserve does not constitute a reserve for purposes of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964." In the abovesaid decision, the Bombay High Court after going through several decisions of the Supreme Court on this aspect held as under (page 579) : " We have gone through the above three decisions of the Supreme Court as well as the Calcutta and Karnataka High Courts' decisions relied on by Shri Mehta carefully. No doubt, there is an observation in the Supreme Court decisions that a provision is a charge against profits. It is, however, seen that in CIT v. Laxmi Sugar and Oil Mills Ltd. [1986] 161 ITR 168, the Supreme Court referred to its earlier decision in Vazir Sultan Tobacco Co. Ltd.'s case [1981] 132 ITR 559. In that case, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ere a debenture redemption reserve was created out of the profits of the company and the payment to the debenture-holders on account of principal and interest was made out of funds other than the debenture redemption reserve account and an amount equal to the cash applied in redeeming the debentures was transferred from the profit and loss account to the capital redemption reserve fund in order to conserve working capital, i.e., to prevent reduction of capital, in such a case, the debenture redemption reserve is a reserve and not a provision and is to be taken into account for computing capital for purposes of surtax under Schedule II of the Companies (Profits) Surtax Act, 1964. " The distinction between a provision and a reserve is in commercial accountancy fairly well-known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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