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TMI Blog1980 (9) TMI 48X X X X Extracts X X X X X X X X Extracts X X X X ..... d be treated as reserve and included in the computation, of capital. But this contention was rejected by the revenue authorities. (ii) It has been held by their Lordships of the Gujarat High Court in the case of CIT v. Viramgam Mills Co. Ltd. [1961] 43 ITR 270 at p. 279, that if any part of the amounts deducted for depreciation did not represent the true amount of depreciation suffered by the buildings and machinery of the assessee-company, then to the extent of such excess it could be said that the reserve had been built up out of the profits of the company. The present appeal comes squarely within the ratio of the above judgment. We, therefore, accept the assessee's contention that the depreciation provided in the books in excess of the depreciation allowed for income-tax assessment should be treated as reserves for computation of capital." As we have noticed before, the short question is whether the excess amount of the depreciation of the sum of Rs. 58,85,850 should be allowed to be considered as a reserve within the meaning of r. 1 of the Second Schedule to the S.P.T. Act, 1963. The expression " reserve " under r. 1 of the S.P.T. Act, 1963, has been considered in several ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tal of the company under the S.P.T. Act, the amount of taking decision for the company, which normally means the board of directors, to keep it as a reserve as such. On the contrary, it was sought to be urged that they had treated this as a provision. It was, secondly, submitted that this was an excess depreciation and, therefore, it was really a provision for depreciation that the company had provided for in the balance-sheet. Therefore, according to the company's own judgment, it represented the depreciation which normally should be debited against the profit and was not to be set apart out of the profit. In this connection, reliance was placed on certain authorities on accountancy, which we shall presently note, and it was thirdly urged that, in view of Expln. 1 to the Second Schedule to the S.P.T. Act, 1963, this so-called depreciation cannot be considered to be capital for computing the capital of the company for the purpose of this Act. In this connection, reliance was placed on certain observations in an unreported judgment in the case of Income-tax Reference No. 50 of 1976, Upper Ganges Sugar Mills Ltd. v. CIT (judgment delivered on 24th August, 1978) [since reported in [19 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... -sheet the sum of Rs. 70,33,000 was shown as adjustment of excess depreciation on buildings, machinery, etc., being the difference between the amount provided and the amount calculated under s. 205(2)(b) of the Companies Act, 1956, up to 30th June, 1967. The company was claiming depreciation according to the written down value method adopted up to the earlier assessment year. But in this year it changed the said method and adopted the straight line method and adjusted the excess depreciation of Rs. 70,33,000 computed under s. 205(2)(b) of the Companies Act, 1956. The ITO deducted the statutory deduction of Rs. 94,33,000, being the " general reserve ", which included Rs. 70,33,000, being adjustment of excess depreciation. The Addl. Commissioner, acting under s. 16 of the Act and after hearing the company, held that the general reserve to the extent of a sum of Rs. 70,33,000 was created by the company by revaluation of the assets and it was brought into existence by creating or increasing, by a revaluation or otherwise, the book assets and, therefore, the aforesaid amount was erroneously included by the ITO in the computation of the capital of the company. Now, this finding that th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ension reserve and up to 30th June, 1961, the directors described the amount as a reserve for pension fund and the amount was shown in the balancesheet as reserve and as surplus. But, admittedly, the expenditure incurred in respect of pensions had regularly been debited to the profit and loss account. Similarly, for the period 30th June, 1956, to 30th June, 1958, the amount for roofing repairs was shown as a provision for roofing repairs and under the head " Current Liability and Provision ". Since 30th June, 1959, the amount had been shown as reserve " for roofing repairs under the head " Reserves and Surplus That amount again admittedly, had been debited to the profit and loss account. It was further held that taking the matter as a whole, that is to say, past conduct and the fact that both the roofing repairs and the pension liabilities were incurred out of these funds, we are of the opinion that this should not be considered as a " reserve " in terms of the section. The said decision cannot be said to be an authority for the proposition that something more than profit kept apart for some future use was required to be treated as a reserve. Reliance was placed, as we have indic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... view of the state of affairs; asset should be shown at a figure which represents that part of their value on acquisition, which has not yet expired." Reliance was placed on the observation at page 59, where the learned editors observed as follows: " Where the cost of replacement is estimated to exceed the cost of the original asset, and it is not desired to introduce new capital to meet the excess, but it is the intention to provide it out of profits, the fund must be computed at the amount as is necessary for the acquisition. As already indicated, the excess of the provision over the true depreciation charge should preferably be regarded as an appropriation of profits, not a charge against them." Certain recommendations of the Institute of, Chartered Accountants were also relied on, which were noted in the said book of Spicer and Pegler. The recommendation of the Council of the Institute of Chartered Accountants on the methods which should be applied in providing for depreciation of fixed assets may be set out below (p. 63, para. 5): " Amounts set aside out of profits for obsolescence which cannot be foreseen, or for a possible increase in the cost of replacement, ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed requirements must be regarded as a reserve, and ........ Page 0720: " As already stated any amount set aside in excess of a necessary provision is a reserve and should appear so in the balance-sheet. For example, in regard to stock, the amount required to cover the excess of cost over, say, net realizable value is a provision; any further amount, e.g., in respect of a possible future fall in values, is a reserve." Page 2332: " (a) The expression 'provision' shall, subject to sub-paragraph (2) of this paragraph, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy; (b) The expression 'reserve' shall not, subject to as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability or any sum set aside for the purpose of its being used to prevent undue fluctuation in charges for taxation; (2) Where: (a) Any amount written off or retained by way of pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s effected between the parties for providing financial collaboration, supply of plant and machinery and technical know-how. Under the basic agreement the assessee got plant and machinery on deferred payment terms. 20% of the cost of plant and machinery was to be paid at the time of signing the contract. 80% was to be paid in instalments spread over a period of five years. The rate of interest on the deferred payments was to be 6% per annum. The payment was to be made in pounds sterling and it was specifically agreed that in case of any change in the official rate, the difference caused by the change would be adjusted at the time of the payment of each instalment. The assessee included an amount of Rs. 3,65,040 being the interest at 6% on the cost of machinery and plant, and an amount of additional interest due to the devaluation of rupee in determining the actual cost of plant and machinery for purposes of depreciation and development rebate. The Revenue had contended that the interest paid would not form part of the actual cost of plant and machinery and in any event the interest paid after the assessee-company went into production could not be capitalised. It was held that the ob ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e question and the facts and the question posed before the Division Bench was whether, in the facts and circumstances of the case. " depreciation fund " constituted a reserve within the meaning of the first proviso to s. 23A(1). Learned advocate for the revenue strongly relied on the observations of the court at p. 280 of the report, where Chief justice Chagla of the Bombay High Court in that case (Bipinchandra Maganlal Co. Ltd. v. CIT [1955] 28 ITR 1) had observed at p. 6 as under: The real position, it seems to us, is this that when an asset is depreciated from year to year and the depreciation is debited to the profit and loss account and comes out of the profits of the company, that amount constitutes a reserve created by setting apart a portion of the profits from year to year and not distributing those profits or not otherwise dealing with those profits." Those observations, in our opinion, rather support the contention of the assessee than that of the revenue because if it is separated and set apart out of the undistributed profit for a specific purpose for future use, and as we have indicated before in Karam Chand Thapar's case [1981] 131 ITR 175 (Cal), for utilisatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sum set apart for payment towards specific liability cannot be said to be a reserve for future use of the company. The sum has, therefore, to be treated as not a reserve. So far as the provision for taxation is concerned, the total sum set apart was Rs. 7,50,000 as against the actual tax liability of a sum of Rs. 3,87,040. The said sum of Rs. 3,87,040 have been paid out of the company for discharging the actual tax liability; it cannot be taken to be an amount set apart or appropriated for a specific purpose, or for future use of the company and is only a provision made for discharging a specific liability. Therefore, the said sum cannot be treated as a reserve. But the balance of Rs. 3,62,960 representing the excess provision for taxation was available to the company for its use and, therefore, it has to be treated as a reserve." The Madras High Court again, in order to deal with excess depreciation in the case of United Nilgiri Tea Estates Co. Ltd. v. CIT [1974] 96 ITR 734, was dealing with the said question of reserve under r. 2(1) of the Second Schedule to the S. P. T. Act, 1963, and at p. 736 observed as follows : " In this case, though a sum of Rs. 12,16,000 has been s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... purpose of income-tax was conscious of the fact that the depreciation provided for was insufficient as per the provisions of the Income-tax Act and, in fact, the contention of the assessee-company was accepted because the depreciation in its books of account was provided on the footing of straight-line method while, in fact, the depreciation to be calculated in accordance with the provisions of the Income-tax Act was much larger. For computing its income for the purpose of the Income-tax Act such larger amount of depreciation was allowed and the excess amount, i. e., the amount of difference between the amount of depreciation actually allowed for the purpose of the Income Act and the amount of depreciation actually provided in the books of the assessee-company, was diverted as forming part of the general reserve and actually the amounts that were credited to the general reserve included within its item such difference between the amount of depreciation allowed for the purposes of the Income-tax Act and the amount of depreciation actually provided in the books. Thus, on a plain interpretation of the language used in clause (iii) of rule 1 of the Second Schedule to the Act, it is qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was held that the setting apart of the sum of Rs. 40 lakhs in the balance-sheet as on December 31, 1961, for contingencies, which according to the assessee-company's own statement before the Tribunal, was for the purpose of meeting a liability which might arise as a result of an award that might be made in an industrial adjudication, which was pending under a statute, would have to be regarded as a provision made for a known contingent liability, the quantification whereof was to depend upon either the actual award that would be made by the adjudicating machinery or as result of a settlement that might be arrived at by the parties. Therefore, the setting apart of the sum of Rs. 40 lakhs being in the nature of a provision would not be includible in the capital computation of the assessee-company for the purpose of the S.P.T. Act, 1963. In view of the proposition that we have enunciated from the decision of Karam Chand Thapar's case [1981] 131 ITR 175 (Cal) and in view of the fact that in this case it is admittedly the position that there was an excess depreciation which had been mentioned as " excess " for depreciation purposes, it had been kept apart for use in future. It is t ..... X X X X Extracts X X X X X X X X Extracts X X X X
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