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TMI Blog1992 (9) TMI 57X X X X Extracts X X X X X X X X Extracts X X X X ..... facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in law in admitting the additional ground raised by the assessee that the Income-tax Officer was not justified in rectifying the order so as to reduce the capital computed by Rs. 9,53,220 for the assessment year 1967-68 as there was no mistake rectifiable under section 13 of the Companies (Profits) Surtax Act, 1964 ? " Topic II: The question pertaining to deduction of proposed dividend from general reserve. Assessment year 1967-68: " 2. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs. 9,53,220 proposed dividend should not be deducted from the general reserve while computing the capital employed by the assessee ? Assessment year 1968-69 : " 1. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs. 12,28,110 proposed dividend should not be deducted from general reserve while computing the capital employed by the assessee ?" Assessment year 1969-70: " 3. Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that Rs. 14,68, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xml:namespace prefix = st2 /> February 19, 1970 , by the Assessing Officer. The capital employed by the assessee during the relevant year was determined by the Assessing Officer at Rs. 1,56,72,702. He took into consideration the following three items as per rule 1 of the Second Schedule to the said Act : (Rs.) Paid-up capital as on January 1, 1966 69,97,800 Proportionate increase for 158 days of Rs. 18,32,600 (being the value of bonus shares issued on July 27, 1966 ) : 7,93,318 General reserve 60,75,000 Subsequently, by his order dated December 13, 1973, the Income-tax Officer rectified the assessment under section 13 of the said Act holding that the general reserve should have been taken at Rs. 52,81,682 as against Rs. 60,75,000 as the sum of Rs. 7,93,318 which was added to the paid up capital in the original order for the reason that it represented proportionate increase for 158 days of Rs. 18,32,600 but was also a part of the general reserve of Rs. 60,75,000 inasmuch as the paid up capital had been increased by the company to the extent of Rs. 18,32,600 by issuing bonus shares after capitalising the sum of Rs. 18,32,600 from the general reserve account. By another or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ying the order so as to reduce the capital computed by Rs. 9,53,220 for the assessment year 1967-68 as there was no mistake rectifiable under section 13 of the Act. That decision of the Tribunal resulted in the first question posed for our opinion as mentioned at the outset of this judgment. So far as the question of dividend was concerned, the Tribunal took the view that Rs. 9,53,220 by way of proposed dividend cannot be deducted from the general reserve while computing the capital employed by the assessee. On the question of giving credit for proportionate value of bonus shares, the Tribunal held on the interpretation of rule 3 of the Second Schedule to the said Act that the assessee had to be given credit for proportionate value of bonus shares and no adjustment was possible in the general reserve by reducing the amount of general reserve which was taken in computation under rule 1 by the Income-tax Officer. So far as the loan taken by the assessee-company from the Bank of Baroda was concerned, it was held that it had qualified for inclusion in the computation of its capital for the purpose of the said Act. As all these findings were rendered against the Revenue and in favour ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In the original assessment, the Income-tax Officer had accepted the assessee's contention that the entire general reserve would form part of capital employed as on January 1, 1966 . Later on, an order under section 13 passed by the Income-tax Officer on February 12, 1974, he held that the sum of Rs. 9,53,220 represented dividend proposed and formed part of current liabilities and provisions which had to be deducted in arriving at the capital employed. For that purpose, Explanation I was pressed into service. The Appellate Assistant Commissioner also relying upon the said Explanation, negatived the claim of the assessee and dismissed its appeal against the rectification order of February 12, 1974 . The Tribunal took the view that till the shareholders approved of the proposal of the directors to distribute dividends, there was no current liability or provision as contemplated by Explanation I of the Second Schedule to the Act and, therefore, the Income-tax Officer was not justified in deducting Rs. 9,53,220 from the general reserve while computing the capital employed by the assessee. In order to appreciate the reasoning which weighed with the Tribunal, it is necessary to have a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under: "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, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922 (11 of 1922), or under sub-section (3) of section 34 of the Income-tax Act, 1961 (43 of 1961) ; (iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961) ; (iv) the debentures, if any, issued by it to the public: Provided that according to the terms and conditions of issue of such debentures, they are not redeemable before the expiry of a period of seven years from the date of issue thereof ; and (v) any moneys borrowed by it from Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution which the Cen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ividend to be paid to the shareholders can be considered to be a provision so as to get excluded from the amount of general reserve while considering the balance of general reserve as per rule 1(iii) for the purpose of computation of capital employed by the company for the purpose of surtax to be charged from the company. It is true that the Tribunal following the decision of the Bombay Tribunal has held this point against the Revenue and in favour of the assessee. However, this question is no longer res integra as it has been set at rest by the decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559. Tulzapurkar J., speaking for the Supreme Court, laid down as under ( headnote ) : " The expression 'reserve' has not been defined in the Super Profits Tax Act, 1963, or the Companies (Profit) Surtax Act, 1964. The dictionaries do not make any distinction between the two concepts 'reserve' and 'provision' while giving their primary meanings, whereas in the context of those Acts a clear distinction between the two is implied. Though the expression 'reserve' is not defined, since it occurs in taxing statute applicable to companies only and to no other a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ue nature and character of the appropriation must be determined with reference to the substance of the matter : this means that one must have regard to the intention with which and the purpose for which the appropriation has been made, such intention and purpose being gathered from the surrounding circumstances. The following aspects provide some guidelines : (a) a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general reserve or a specific reserve, (b) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised in future for a specific purpose and on a specific occasion, and (c) a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend in the same year would run counter to any intention of making that amount a reserve. An amount set apart by the board of directors of a company for liabili ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hargeable under the Act. As the said decision is rendered in connection with the very same loans taken by the assessee-company from the Bank of Baroda and which have been held to be includible in the capital computation of the company for earlier years under the very same Act, the ratio of the decision of this court in New India Industries Ltd. v. CIT [1977] 108 ITR 181 will squarely get attracted for answering similar and identical questions covered by Topic 111.Consequently, question No. 2 for the assessment year 1968-69 and question No. 2 for the assessment year 1969-70 under the same topic will have to be answered in the affirmative, in favour of the assessee and against the Revenue. Questions covered by Topic IV: That takes us to consideration of the last Topic IV. To recapitulate, these questions pertain, to the giving of credit for proportionate value of bonus shares and they arise in connection with the assessment years 1967-68 and 1969-70. So far as these questions are concerned, it is necessary to have a look at rule 3 of the Rules found in the Second Schedule. Rule 3, reads as under : "Where after the first day of the previous year relevant to the assessment year t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The aforesaid analysis of rule 3, therefore, makes it clear that before rule 3 can be pressed into service by the assessee-company, it must be shown that the capital base for the said company as on the first day of the previous year relevant to the assessment year as per rule 1 undergoes a hike after that day, of course, during the relevant assessment year. If this basic condition is not satisfied, rule 3 will not be attracted at all and, consequently, there will be no occasion for the concerned assessee-company to claim the benefit of consideration of increase in the capital base so computed to the extent indicated by the last part of rule 3. In other words, rule 3 will not click at all and would be out of the picture for computing the capital of the company for the purpose of surtax as per the Second Schedule. In the light of the aforesaid clear statutory scheme of rule 3, let us see whether factually, in the present case, there was any increase in the capital base of the company as computed on the first day of the previous year relevant to the assessment year, by any increase in that capital base under the contingencies contemplated by rule 3. In order to focus attention on th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d on June 27, 1966 , by way of issuance of bonus shares had the following two effects. (1) Rs. 7,93,318 got added to the paid-up share capital of the company as earlier existing on January 1, 1966 , and (2) to the same extent, the general reserve of Rs. 60,75,000 got depleted with the result that general reserves were reduced to Rs. 52,81,682. In short, what was added to the paid-up share capital was reduced from the, general reserve figure. Consequently, the original amount of capital base as on January 1, 1966 , considering paid-up share capital and general reserve figures remained the same even on July 27, 1966 . As shown earlier, by adding two figures of the paid-up capital of Rs. 77,91,118 and reduced general reserve figure of Rs. 52,81,682, the aggregate of the capital base again works out to Rs. 1,30,72,800. Consequently, there was no increase in the capital base as computed under rule as on January 1, 1966 , even on July 27, 1966 , when part of the general reserve was capitalised and was converted into bonus shares. On these facts, therefore, the conclusion becomes inevitable that the capital of the company as computed as per rule 1 as on January 1, 1966, for the rele ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al as on July 27, 1966, by adding Rs. 7,93,318 to the figure of paid-up capital as on January 1, 1966, and the corresponding automatic deduction to the same extent in the figure of general reserve out of which this amount has flown should be ignored. That would be contrary to the accepted principles of accountancy and even simple arithmetic. In this light, it would be profitable to have a look at the earlier provision which was found in rule 2 of the Second Schedule to the Super Profits Tax Act, 1963. The said rule read as under: " 2. Where after the first day of the previous year relevant to the assessment year, the paid up share capital of a company is increased or reduced by any amount during that previous year, the capital computed in accordance with rule 1 shall be increased or decreased, as the case may be, by a portion of that amount which is proportional to the portion of the previous year during which the increase or the reduction of the paid up share capital remained effective." A mere look at the said rule as contrasted with present rule 3 of Schedule II of the 1964 Act, will show that as per earlier rule 2 of the 1963 Act, all that was taken into consideration was i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reserve as might be existing on the first day of the previous year, would result in a real increase in the capital base of the company or not. For deciding that question, the aforesaid decision relied upon by the learned advocate for the assessee would not be of any assistance. The learned advocate for the Revenue on the other hand invited our attention to the decision of the Bombay High Court in CIT v. Century Spg. and Mfg. Co. Ltd. [1978] 111 ITR 6. Considering this very question, it was held interpreting rule 3 of the Rules by the Division Bench consisting of Kantawala C.J. and Tulzapurkar J. (as he then was ), that (headnote): "If, during the course of the previous year, a part of the amount standing to the credit of the general reserve is capitalised by issue of fully paid up bonus shares, it cannot be said that the capital of the company computed in accordance with rule 1 of the Second Schedule is increased by any amount by such issue of bonus shares. What happens in such case is that a part of the sum standing to the credit of one of the sub-items to be included in the computation of capital is during the previous year transferred to another item to be included in the co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the two decisions of the Calcutta High Court. In Alkali and Chemical Corporation of India Ltd. v. CIT [1980] 122 ITR 490, the Division Bench of the High Court, speaking through Dipak Kumar Sen J., made the following pertinent observations ; while interpreting rule 3 firstly in isolation and then in the context of rules 1 and 2, rule 3 of the Second Schedule ( headnote): "Rule 3 of Schedule II to the Companies (Profits) Surtax Act, 1964, read in isolation from the other rules may suggest that any increase or decrease in the paid up share capital by itself would lead to an increase or decrease of the capital. There is no indication in this rule that there has to be a further inquiry as to the depletion of the capital on the other items. But if rule 3 is read along with rules 1 and 2, the matter becomes clear. What is ultimately to be computed under Schedule 11 is the amount of capital and in the computation of the amount of capital the amount of reserve is a necessary item. While taking note of the increase of the share capital by issue of bonus shares out of reserves, the corresponding decrease in the amount of reserves cannot be overlooked. It may be possible to take two views ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... increased during the previous year by way of an addition to any part of the capital so computed, whether the increase is to the paid-up capital or whether it be to the reserves or to any other item figuring on the liabilities side of the balance-sheet. In other words, there must be a fresh influx of capital into the company in order to attract rule 3. " The same view is taken by the Delhi High Court in Addl. Commissioner of Surtax v. Food Specialities Ltd. [1981] 129 ITR 731. Ranganathan J. (as he then was ), speaking for the Delhi High Court, while interpreting rule 3 of the Second Schedule made the following pertinent observations headnote ) : " Rule 3 of Schedule II contemplates an increase in the capital computation only where there is an increase in the capital of the company as computed in accordance with the earlier rules, that is to say, an increase in the capital of the company as computed in accordance with rule 1. In a case where the paid-up capital is increased but this is done by utilising a portion of the reserves which have been taken into account in the capital computation as on the first day of the previous year, then it is clear that the capital of the company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of that rule that the benefit of increase in paid-up share capital would accrue to the assessee-company. In fact, that is precisely the reason why the Division Bench of the Bombay High Court in CIT v. Geoffrey Manners and Co. Ltd. [1978] 112 ITR 334, while interpreting rule 2 of the 1963 Act took the view that in the light of the language of rule 2 in the Second Schedule to the 1963 Act, it is clear that by reason of the issuance of such bonus shares 'the paid up share capital' of the company could be said to have been increased. The simple question that the court was called upon to decide was whether the paid up share capital of a company is increased or not, and it can never be disputed that by issuance of bonus shares, the paid-up capital of a company is increased. The assessee was, therefore, entitled to the proportionate increase of Rs. 2,14,495 in terms of the Second Schedule to the 1963 Act. The Division Bench, therefore, distinguished its, own decision in CIT v. Century Spg. and Mfg. Co. Ltd. [1978] 111 ITR 6. In fact, the decision in CIT v. Geoffrey Manners and Co. Ltd. [1978] 112 ITR 334 (Bom) falls in line with the Himachal Pradesh High Court decision in CIT v. Mohan M ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he Division Bench to consider whether the ratio of the Division Bench judgment of the Bombay High Court in CIT v. Century Spg. and Mfg. Co. Ltd. [1978] 111 ITR 6 was right or not. If they had disagreed with that ratio, they would have referred the matter to a larger Bench. But they have not done so as they have concentrated only on the interpretation of rule 1 de hors rule 3. Such is not the position in this case. The questions referred to us are widely worded and they include both positive and negative aspects, viz., whether the Tribunal was right in law in holding that the assessee had to be given credit for proportionate value of bonus shares in view of rule 3 of the Second Schedule to the Act and that for this purpose, no adjustment should be made to the general reserve. Thus, aspects of both proportionate increase in the paid up capital and corresponding deduction in the general reserves for the purpose of rule 3 are placed for our consideration in these questions and, consequently, the entire working of rule 3 in juxtaposition with rule 1 is open on the anvil of consideration before us. It is, therefore, not possible to agree with the contention of the learned advocate for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ievance was that proportionate reduction in the general reserves was not made and, therefore, he made a proportionate deduction in the general reserve. Therefore, so far as the increase in the capital was concerned, the Income-tax Officer having accepted the company's case, the Revenue cannot now go behind the same and urge that there is no increase as per rule 3. This submission is totally misconceived for the simple reason that as discussed earlier, for applicability of rule 3, it must be shown that there was increase in the capital base as existing on the first day of the previous year and as computed as per rule 1, granting of proportionate increase in the paid up share capital subsequently by the issuance of bonus shares would not mean that the Revenue had conceded at any stage that rule 3 benefit will be available to the assessee. The submission of the learned advocate of the assessee wrongly assumed that the proportionate increase in the paid-up share capital for the purpose of rule 3 is equivalent to increase in the capital base as computed under rule 1. Such an argument in the light of the clear language of rule 3 of the present Act cannot be sustained. It would have stood ..... X X X X Extracts X X X X X X X X Extracts X X X X
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