TMI Blog1985 (9) TMI 69X X X X Extracts X X X X X X X X Extracts X X X X ..... er, on the facts and in the circumstances of the case, the following amounts were includible in the computation of capital of the assessee under rule I of the Second Schedule to the Companies (Profits) Surtax Act, 1964: Rs. (i) Contingency reserve 20,72,000 (ii) Reserve for doubtful debts 10,17,481 (iii) Surtax reserve 20,83,115 (iv) Dividend tax reserve 7,50,000 (v) Retirement gratuity reserve 48,82,698 ?" The questions referred pertain to the computation of capital or capital base, as it is called, for the purpose of the. Companies (Profits) Surtax Act, 1964. We propose to refer to the said Act hereafter as " the Companies Surtax Act ". Section 4 of the Companies Surtax Act, in brief, provides that subject to the provisions of that Act, there shall be charged on every company for every assessment year commencing on and from the I st day of April, 1964, a tax on 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. Clause (5) of section 2, the definition section, provides, in short, that " chargeable profits " means the total income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xth Schedule to the Companies Act, 1956. The assessee preferred appeals against the assessment orders passed by the Income-tax Officer in respect of the said assessment years. The Appellate Assistant Commissioner hearing the said appeals held that the amount of retirement gratuity reserve would have to be included in the capital computation and, as regards the other amounts, relying on the Explanation to rule I of the Second Schedule to the Companies Surtax Act and the definitions of the expressions "reserve" and "provision" in Part III of the Sixth Schedule to the Companies Act, he came to the conclusion that the other items of contingency reserve, reserve for doubtful debts and super profits tax, surtax and dividend tax reserve for each of the years under consideration were " provisions " and not " reserves ". Both the assessee and the Revenue preferred appeals to the Tribunal against the order of the Appellate Assistant Commissioner. Both these appeals were consolidated and heard together and disposed of by common order of the Tribunal from which this reference has arisen. For the reasons set out in paragraphs 6 to 14 of its order, the Tribunal held that the aforesaid reserves, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ons interested in or dealing with companies. Therefore, the meanings attached to the words " reserves " and "Provisions " in the Companies Act, 1956, dealing with the preparation of the balance-sheet and the profit and loss account would govern their construction for the purposes of the two enactments. The broad distinction between the two is that whereas a " provision " is charge against the profits to be taken into account against gross receipts in the profit and loss account, a " reserve " is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business. The question whether the concerned amounts constitute " reserve " or not will have to be decided by having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances, particularly the intention with which and the purpose for which such appropriations had been made. The true 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... propriated without resorting to any scientific basis, such appropriation would also be a provision intended to meet a known liability, though a contingent one, for, the expression " liability " occurring in clause 7(1)(a) of Part III of the Sixth Schedule to the Companies Act includes any expenditure contracted for and arising under a contingent liability. However, if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability, being the discounted present value on a scientific basis, it is only the excess that will have to be regarded as a reserve. In the case before us, in the relevant previous years relevant to both assessment years in question, the assessee company set apart certain amounts on account of gratuity liability, as the assessee appears to have done, merely to add lump sum amounts to the amount already there in the said reserves. It is common ground, therefore, that in respect of gratuity reserve, the case will have to be referred back to the Tribunal to calculate as to whether there is any excess in the amounts set apart for the aforesaid purpose by the company on the deduction from the same of the aggregate estimated gratuit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for surtax in the assessment year 1965-66 and include in the computation of the capital of the assessee company only the excess amounts in these reserves. There seems to be no objection to this course of action being followed and the Tribunal is directed accordingly. As far as the amounts set aside by way of reserves for doubtful debts in both the said assessment years are concerned, there is no controversy either. The facts found in the decision of the Tribunal show that the undisputed factual position was that these reserves were created to cover all debts over six months old and no attempt was made to estimate which of these debts would really become bad debts. The said reserve was thus not created by the assessee on account of any possibility of debts becoming bad. In fact, there are hardly any doubtful debts in the case of the assessee. In view of these facts, it is common ground that the amount set apart by way of reserves for doubtful debts in respect of the said two assessment years have to be included in the computation of capital of the assessee for the aforesaid purposes. We finally come to the question of the dividend tax reserve. This reserve appears in the questi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he company has to be calculated as on the 1st day of the previous year relevant to the assessment year, which in this case would be January 1, 1964. It was submitted by him that in view of this, the entire amount of Rs. 7,50,000 was liable to be included in the capital of the company. It was pointed out by him that in this connection, we have to bear in mind that it is an admitted fact that these reserves were not created on or before January 1, 1964, but during the calendar year 1964. Mr. Dastur relied on the decision of the Supreme Court in CIT v. Mysore Electrical Industries Limited [1971] 80 ITR 566. In that decision, the Supreme Court has pointed out that it is well known that the accounts of the company have to be made up to a particular date. In the case before the Supreme Court, that day was March 31, 1963. If the accounts could have been reasonably made up on that date, the directors could have made up their mind on appropriating various amounts for reserves, but it is practically impossible in any case to make up the accounts of a company on the very next day (after the end) of the accounting year. It was held that the determination to appropriate the sums mentioned earli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... date up to which the accounts are finalised and must be treated as being effective from that date. They further held that once such determination and appropriation are made, they finally determine the character of the allocation and if it relates back to an earlier point of time, then it relates back effectively in all respects and retains its nature and character. A company can take the advantage of the retrospective effect of its determination of appropriation, but it cannot then contend that by being retrospectively effective, the nature of the appropriation will change. This decision, with which we are in respectful agreement, lends considerable support to the view which we have taken. Finally, it was pointed out by Mr. Dastur that the liability to pay the amount of Rs. 7,41,924 imposed as dividend tax had been imposed on the footing that the assessee was a company in which the public was substantially interested. That conclusion has been arrived at by this court in appropriate proceedings. It was pointed out by him that in case this finding is reversed by a higher court, the result would be that the assessee would not be liable to pay any dividend tax at all, although it wo ..... X X X X Extracts X X X X X X X X Extracts X X X X
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