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TMI Blog1981 (11) TMI 19X X X X Extracts X X X X X X X X Extracts X X X X ..... which the relevant accounting years were ended on December 31, 1962, and December 31, 1963, respectively. It appears that on the first day of the accounting year relevant to the assessment year 1963-64, there was a sum of Rs. 25,38,694 shown as surplus in the balance-sheet of the assessee. It would be relevant to set out the balance-sheet as on December 31, 1962, on the reserve and surplus items, which read as follows: " II. Reserves & Surplus(Schedule2) Rs. Capital reserves-Share premium account 70,00,000 Revenue reserves-General reserve 3,49,24,162 Development rebate reserve 74,50,000 Doubtful or bad debts reserve 12,00,000 Surplus 25,88,011 ----------- 4,61,62,173 ----------- In the directors' report to the shareholders presenting the statement of account for the year ended December 31, 1962, the directors had observed as follows : " Reserves and surplus. The development rebate reserve has been increased by a further Rs. 3,00,000 and now totals Rs. 74,50,000. General reserve has been increased by Rs. 20,00,000." It may also be mentioned that the net profit available for disposal was Rs. 95,59,317. Out of this, the balance-sheet and the P & L a/c. al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e first year was covered by the S.P.T. Act, 1963, and the second year was covered by the C. (P.) S.T. Act, 1964. It is true that the provisions in those two Acts were more or less similar except that, for the second year, r. 1 of the Second Schedule in respect of the computation of capital for the purpose of surtax contained an Explanation, which was not there for the first year. The Tribunal, therefore, for the reasons given for the previous year, rejected the assessee's appeal, Thereafter an application was made by the assessee for a reference u/s. 256(1) of the I.T. Act, 1961, which was rejected. Thereupon the assessee came up before this court and, as mentioned hereinbefore, as directed by this court, two questions have been referred, as indicated before. Before we take up the material question involved in this reference, in order to complete the narration of facts we must note that, for the second year, our attention was drawn to the balance-sheet and the P & L a/c. for the year ended December 31, 1963, which was passed some time after March 26, 1964. It appears that the directors in their report presenting the statement of account for the year ended December 31, 1963, had o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany under the provisions of this Schedule. " On this aspect, the Tribunal has relied mainly on the ground that the sum represented only a mass of undistributed profit and there was no evidence that anybody had decided to treat this as reserve as such. Our attention was drawn to a decision of the Supreme Court in the case of CIT v. Century Spg. and Mfg. Co. Ltd. [1953] 24 ITR 499. There the Supreme Court was considering the profit for the year ended December 13, 1945, and it was found that the profit of the assessee-company, whose accounting year was a calendar year, was a certain sum according to the P & L a/c. After making provisions for depreciation and taxation the balance of Rs. 5,08,637 was carried to the balance-sheet. This sum was not allowed in computing the profits of the assessee for the purposes of income-tax. In February, 1946, the directors recommended that out of that amount a sum of Rs. 49,22,436 should be distributed as dividend and the balance of Rs. 16,211 was to be carried forward to the next year's account. This recommendation was accepted by the shareholders in their meeting of April 3, 1946, and the amount was shortly afterwards distributed as dividend. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... took no action to set, aside any portion of this sum as a reserve or reserves. Indeed, they bad never applied their mind to this aspect of the matter. On behalf of the Revenue our attention was drawn to the decision in the case of CIT v. Standard Vacuum Oil Co. [1966] 59 ITR 685. There the Supreme Court was concerned with the business profits tax in respect of an American company and was concerned with the excess value of assets transferred. There the facts were, of course, entirely different. There the assessee, a non-resident company incorporated in Delaware in U.S.A. with the object of taking over the assets of two other companies, the Socony Vacuum Oil Co. and the Standard Oil Company, New Jersey, in consideration of the transfer of assets valued in their books at $ 97,715,701 and $ 46,767,397, respectively, allotted to each company 49,995 shares of $ 100 each and to Socony Vacuum Oil Co. serial bonds of the value of $ 13,093,000. The remaining ten shares of the share capital of the assessee-company were divided equally between the two companies for cash. The assessee-company entered in its books of account the book value of the assets taken over from the companies and the exc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (1953] 24 ITR 499 (SC), and after referring to the observations at p. 695, the Supreme Court also referred to the decision of the Supreme Court in the case of First National City Bank v. CIT [1961] 42 ITR 17 and thereafter referred to the observations of Mr. Justice Kapur in the said case where the learned judge had observed as follows (p. 695 of 59 ITR) "`There is a difference between the system of accounting of banking companies in India and the United States ...... In India at the end of an year of account the unallocated profit or loss is carried forward to the account of the next year, and such unallocated amount gets merged in the account of that year. In the system of accounting in the U.S.A. each year's account is self-contained and nothing is carried forward. If after allocating the profits to diverse heads mentioned above any balance remains, it is credited to the 'Undivided profits' which become part of the capital fund. If in any year as a result of the allocation there is a loss the accumulated 'Undivided profits' of the previous years are drawn upon and if that fund is exhausted the banking company draws upon the, surplus. In its very nature the 'Undivided profits' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... each instance composed of two sums, one carried forward or brought over from an earlier year and the other being the balance of the immediately preceding. That distinction, in fact, does not seem to me to make any difference, once it is borne in mind what the test was that the Supreme Court laid down. The crucial date, if I may borrow the language of their Lordships, is the first day of the relative chargeable accounting period and the one fact which, in their Lordships' view, furnished the answer to the question they had to consider was that on that crucial date, nobody possessed of the requisite authority had indicated the manner Of the disposal Or the destination of the balance concerned. The amount of the balance had been simply pushed forward to the next year without being allocated to any particular purpose, whether general or special, and their Lordships held that if a surplus was simply carried forward without the persons in requisite authority allocating it to any particular purpose as a reserve, it did not acquire the character Of reserve for the purposes of capital computation under the Business Profits Tax Act. If that be the test, in my view it applies to the whole of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... refore, the meanings attached to these two words in the provisions of the Companies Act dealing with the preparation of the balance-sheet and profit and loss account would govern their construction for the purpose of the two taxing enactments. The Supreme Court was further of the view that on a plain reading of cl. 7(1)(a) and (b) and cl. 7(2) of Pt. III of Sch. VI of the Companies Act it would clearly appear that though the term " provision " was defined positively by specifying what it meant, the definition of " reserve " was negative in form and not exhaustive in the sense that it only specified certain amounts which were not to be included in the term " reserve ". In other words, the effect of reading the two definitions together was that if any retention or appropriation was not provision, it was automatically a reserve. The question would have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation had been made, because the substance of the matter was to be regarded and in this context the primary dictionary mea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mpanies only and to no other assessable entities and as such the expression will have to be understood in its ordinary popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to these two words in the provisions of the Companies Act, 1956, dealing with preparation of balance-sheet and profit and loss account would govern their construction for the purposes of the two taxing enactments. We might mention here that in CIT v. Century Spg. and Mfg. Co. Ltd. [1953] 24 ITR 499 (SC), this court, after referring to the dictionary meaning of the expression ' reserve ', observed: 'what is the true nature and character of the disputed sum (sum allegedly set apart), must be determined with reference to the substance of the matter' and went on to determine the true nature and character of the disputed sum by relying upon the provisions of the Indian Companies Act, 1913, the form and the contents of the balance-sheet required to be drawn up and regulation 99 in Table A of the First Schedule. The distinction between the two concepts of ' reserve ' an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tention with which and the purpose for which such retention or appropriation has been made because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term ' reserve ' may have to be availed of. But it is clear beyond doubt that if any retention or appropriation of a sum is not a provision, that is to say, if it is not designated to meet depreciation, renewals or diminution in value of assets or any known liability the same is not necessarily a reserve. We are emphasising this aspect of the matter because during the hearing almost all counsel for the assessees strenuously contended before us that once it was shown or became clear that the retention or appropriation of sum out of profits and surpluses was for an unknown liability or for liability which did not exist on the relevant date it must be regarded as reserve. The fallacy underlying the contention becomes apparent if the negative and non-exhaustive aspects of the definition of 'reserve' are borne in mind. Having regard to type of definitions of the two concepts which are to be found in cl. 7 of Part III, the proper approach in our view would be first to ascertain whether th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... les and on the basis of the guidelines discussed above, the Supreme Court felt it unnecessary for them to go on to discuss the scope or effect of the Explanation to r. 1 in the Second Schedule to the 1964 Act, though the Supreme Court felt that, prima facie, that Explanation was declaratory of the existing legal position. Bearing the aforesaid principles in mind, so far as the first year is concerned, viz., January 1, 1962, in the balance-sheet it appeared that the directors observed the general reserve increased by Rs. 20 lakhs and the directors had treated this amount of Rs. 25,88,011 as surplus after making specific provisions for other contingencies and also provisions for dividend and other matters. It appears to us that this sum could not be treated as provision. Though it was a mass of undistributed profits the directors had decided not to earmark it for any specific contingency or purpose. Therefore, having regard to the substance of the matter and following the principles of the Supreme Court in the last-mentioned case, on the facts of this case, it should be held that the sum represented a reserve in terms of the relevant r. 1 in the Second Schedule. So far as the next ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or 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 to the account 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 ending March 31, 1963, was bound to take some time cannot make any difference to the nature or quality of the appropriation of the profits to reserves as determined by the directors after the first of April, 1963. Their determination to appropriate the sums mentioned to the three separate classes of reserves on the 8th August, 1963, must be related to the 1st of April, 1963, i.e., the beginning of the accounts for the new year and must be treated as effective from that day." This view finds corroboration in the observations of the Bombay High Court in the case of Parke Davis (India) Ltd. v. CIT [1981] 130 ITR 813, where ..... X X X X Extracts X X X X X X X X Extracts X X X X
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