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TMI Blog1980 (8) TMI 28X X X X Extracts X X X X X X X X Extracts X X X X ..... ding in this respect is perverse ? " In order to appreciate this question, it is necessary to state that the assessee is an Indian company with its previous year as calendar year 1967. While computing the capital as on 1st January, 1967, under the C. (P.) S. T. Act, 1964, the ITO found that the assessee's directors submitted their report for the year ending 31st December, 1966, on 26th May, 1967, and therein had recommended dividend of 10 per cent. of the increased capital of the assessee-company which was subsequently ratified by the shareholders on 29th June, 1967, at the annual general meeting on the accounts for the calendar year 1966. It is pertinent to note that the directors had mentioned in the report that the recommendation for declaration of dividend was made subsequent to the closure of the accounts in 1966 and as such no provision had been made in the accounts for the proposed dividend. After ratification, a sum of Rs. 3,60,000 was, in fact, distributed as dividend among the shareholders and the said amount, therefore, was taken out of the fund as shown as general reserve. Prior thereto, in the accounts, a total sum of Rs. 47,50,660 had been shown as taken out of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AAC was justified in not disturbing the general reserves, and, more so, when the dividend proposed on 26th May, 1967 was ratified by the shareholders on 29th June, 1967, and dividend was thereafter distributed out of general reserves. According to him, the facts of the instant case are materially different from those in the case of CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566 (SC). 5. We have given careful consideration to the rival submissions. There is no dispute as to the facts of the case. The amount of dividend proposed did not appear in the body of the balance-sheet but the recommendation of the directors was very much there and the same was ratified by the shareholders. It is immaterial as to when the directors recommended the amount of dividend to be declared when such recommendation has been appearing in the statement of accounts. A sum of Rs. 10,81,462 was transferred to general reserve out of which the dividend recommended was distributed. If all the facts are examined together one will see that, instead of setting apart a portion of the profits towards dividend, the directors of the assessee-company created, a general reserve out of which the dividend w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of reserves and surpluses or any other item under the head " Current liabilities and provisions ". In essence under r. 1 of the Second Schedule the capital of a company is the aggregate of the amounts as on the first day of the previous year relevant to the assessment year of the paid up capital, the reserves and debentures, etc. The assessee-company claimed for exclusion of the share capital as well as general reserve from computation of capital but the revenue found that out of the general reserve a sum of Rs. 3,60,000 which was, subsequently declared as dividend should be excluded and thereby diminishing the general reserve which should go in the addition of the capital. Now, in this case, admittedly, the relevant date is the first day of the accounting year, that is, 1st January, 1967. As per the balance-sheet, the general reserve was Rs. 47,50,669 and the revenue had deducted from the sum a sum of Rs. 3,60,000 and the assessee disputed the right of such deduction by the revenue. The main basis of the decision of the Tribunal and the case of the revenue is the decision of the Supreme Court in the case of CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566. But before t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eductions for the assessment year 1964-65. The revenue had contended that since the appropriations were made on the 8th August, 1963, this could not be treated as components of capital as on the 1st day of the previous year, that is, 1st April, 1963. It was held, rejecting the contention of the department, that the determination of the directors to appropriate the amounts to the three items of reserve on 8th August, 1963, had to be related back to the 1st of April, 1963, that is, the beginning of the accounts for the next year, i.e. the beginning of the accounts for the new year, and must be treated as effective from that date, and it was held that the three items had to be added to the other items for the computation of the capital of the respondent company as on 1st April, 1963, under r. 1 of Sch. II to the C. (P.) S.T. Act, 1964. Dealing with this aspect, G. K. Mitter J., who delivered the judgment of the Supreme Court, observed at p. 569 of the report as follows: " It is well known that the accounts of the company have to be made up for 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 the accounts up to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt up to the High Court on a reference contending that as the reserve was not sanctioned till 27th June, 1949, it could not be looked at or considered as reserves on a day prior thereto. The learned judges of the Bombay High Court were of the opinion that the resolution of 27th June, 1949, had retrospective effect inasmuch as it referred to the profits of the year ending on 31st December, 1948, the appropriation to be made in the balancesheet as of that date and the reserves which should be constituted and shown in the balance-sheet as on 31st December, 1948. The High Court observed that when one looked at the balance-sheet of the year ended 31st December, 1948, the amounts mentioned were shown respectively in the reserve fund and the dividend reserve fund and the shareholders by passing a resolution on 27th June, 1949, did not decide that these amounts should constitute reserves as from that date but they accepted the recommendation of the directors that these amounts should constitute reserves as of 31st December. The Supreme Court approved the said decision in contradistinction to the Madras decision in the case of CIT v. Vasantha Mills Ltd. [1957] 32 ITR 237. It is significant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... until and unless it was declared or accepted by the shareholders. This identical question, with which we are concerned in the present reference, was considered by this court in the case of Income-tax Reference No. 241 of 1970 [Indian Tube Co. Ltd. v. CIT [1981] 132 ITR 293] a decision to which, as we have mentioned before, learned advocate for the revenue drew our attention subsequently. In that case, on the 1st of May, 1963, in respect of its accounts for the year 1962, the assessee-company in the directors' meeting approved the transfer of a sum of Rs. 90,00,000 out of the profits for the year to a " dividend reserve account ". Thereafter, on the 3rd of May, 1963, the directors recommended the payment of a dividend, out of that " dividend reserve account ", of 12 1/2%, which amounted to Rs. 76,00,000 on the ordinary shares on the amount paid on those shares prior to 31st of December, 1962. On the 31st of May, 1963, in the general meeting, the accounts were passed by the shareholders and the dividend as recommended by the directors were declared. Subsequently, the dividend thus declared was paid later on and it was adjusted by transferring the sum of Rs. 76,00,000 from the " divi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be determined with reference to the substance of the matter and not to the mere entry or nomenclature which the assessee-company might choose to give it. (2) An amount set aside out of profits and other surpluses not to meet a liability, contingency, commitment or diminution in value of assets known to exist at the time of the balance-sheet was a reserve. (3) An amount set aside out of profits and other surpluses to provide for any known liability for which the amount could be determined with substantial accuracy was a provision. (4) Under the I.T. Act an estimated liability ascertainable with substantial accuracy could be taken into consideration in arriving at the true profits and gains. Two reserves with which their Lordships of the Division Bench of the Andhra Pradesh High Court were concerned were, a general reserve of Rs. 28,43,984 and another reserve known by the name " Section 80K tax-free dividend reserve " of Rs. 1,93,577 which found, place in the balance-sheet of the assessee-company for the year ended 31st December, 1970. On the 30th June, 1970, the board of directors of the assessee-company decided to appropriate a sum of Rs. 4,00,000 from out of the general reserve f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mputation of capital under r. 1 of Sch. II to the C. (P.) S.T. Act, 1964. The tax-free dividend reserve had been created with the accumulated profits of the assessee-company and the same had been separately shown in the balance-sheet to have a clear picture of the financial position of the company. The assessee had shown it separately because it was entitled to the exemption under s. 80J of the I.T. Act, 1961, being the profits derived as a new industrial undertaking and the dividend, as and when declared by the company from out of the said profits would, in the hands of the shareholders of the company, be exempt from income-tax under s. 80K of the I.T. Act, 1961. A perusal of the balance-sheet of the board of directors showed that there was no proposal to pay a dividend to the shareholders from out of the said "Section 80K tax-free dividend reserve". It was patent that it was not set aside to meet any liability, commitment, contingency or diminution known to exist at the time of the preparation of the balance-sheet because there was no known liability at the time. Hence, the Tribunal was justified in holding that the sum constituted reserve for the purpose of computation of capita ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee had claimed that the entire sum of Rs. 5.90,000 should be added to the capital as dividend reserve. The ITO rejected the claim but on appeals the AAC and the Appellate Tribunal held that only the balance of Rs. 3,60,000 in the dividend reserve account was includible in the computation of capital as on July 1, 1964, for surtax purposes for the assessment year 1966-67. In the reference before the High Court, it was submitted for the assessee that as a sum of Rs. 1,55,000 was already standing to the credit of the dividend reserve account, only a sum of Rs. 75,000 should be treated as being available from the current profits for payment of the sum of Rs. 2.30,000 as proposed dividend and, therefore, a sum of Rs. 5,15,000 should be regarded as includible in computation of capital for the purpose of surtax. It was held that for the year ending 30th June, 1964, the directors had recommended an aggregate amount of dividend of Rs. 2,30,000. No independent provision was made for payment of this amount but it was stated that it would be paid out of the dividend reserve. From the commercial point of view, if any amount is required for incurring any expenditure or making any disbursements ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stion with which this court was concerned was: " Whether there was any material to hold that there was known liability as on the 1st January, 1967 ? " In the conclusion we have arrived at, it is not necessary to decide this controversy. Though, as we have noticed, in a subsequent decision of the Andhra Pradesh High Court in the case of Super Spinning Mills Ltd. v. CIT [1979] 120 ITR 512, and the decision of the Bombay High Court in the case of CIT v. Indian Smelting Refining Co. Ltd. [1977] 107 ITR 793, as well as in another decision of the Bombay High Court in the case of CIT v. Bharat Bijlee Ltd. [1977] 107 ITR 30, this aspect was considered from a different angle as we have indicated before, yet in view of the ratio of the decision of the Supreme Court in the case of CIT v. Mysore Electrical Industries Ltd. [1971] 80 ITR 566, as understood by the Division Bench of this court in the decision of Indian Tube Co. referred to hereinbefore, the first part of the question is answered in the affirmative and the second part is answered in the negative, both in favour of the revenue in the manner indicated before. Each party will pay and bear its own costs. SUDHINDRA MOHAN GUH ..... X X X X Extracts X X X X X X X X Extracts X X X X
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