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TMI Blog1978 (6) TMI 23X X X X Extracts X X X X X X X X Extracts X X X X ..... ded in its capital base in the said assessment year. The ITO held that the amounts did not represent reserves inasmuch as one of them was specifically earmarked as a provision to meet a particular liability and the other represented unappropriated profits not transferred to a reserve account. The assessee preferred an appeal from the said assessment. The AAC held that the said amount of Rs. 3,35,914 set apart was a provision against a known liability and the other amount of Rs. 11,41,689 was a mass of undistributed profits without any allocation or appropriation. He confirmed the order of the ITO. On a further appeal to the Income-tax Appellate Tribunal, it was contended by the assessee that, as it had not filed any return at the relevant time and as no tax had been determined, therefore, on the 1st January, 1962, the said sum of Rs. 3,35,914 could not be a provision against any accrued liability but was a free reserve includible in the capital base of the company for computation of super profits tax. The other amount of Rs.11,41,689 was stated to have been set apart by the directors of the assessee to be carried over to the next accounting year and, therefore, amounted to a re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e of the S.P.T. Act, 1963. The object of this Act was to impose on and from the 1st April,1963, a special tax called super profits tax on companies on a part of their profits termed as " super profits ", the quantum of normal profits being deemed to be 6% on the capital of the companies. Section 4 of the Act imposed tax on the chargeable profits of companies which would exceed specified standard deductions. Under s. 2(9) of the Act " standard deduction " meant an amount equal to 6% of the capital of the company as computed according to the provisions of the Second Schedule to the Act or Rs. 50,000, whichever would be greater. The First Schedule to the Act laid down rules for computing chargeable profits which broadly consist, inter alia, of the company's income, profits and gains less various amounts including capital gains, compensation under s. 28, royalties, income-tax and super-tax payable in respect of the company's total income except that payable in respect of capital gains and compensation under s. 28. The Second Schedule to the Act contained rules for computing the capital of a company for the purposes of the said Act, inter alia, as follows : " 1. Subject to the other ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ders of the assessee on the 3rd April, 1946. On these facts, the Bombay High Court held that the amount of Rs. 5,08,637 fulfilled all the tests of " reserve " and should be included for the purpose of computation of capital under the Business Profits Tax Act, 1947, the relevant provisions whereof were more or less similar to those of the S.P.T. Act, 1963. The High Court found that Rs. 5,08,637 which could have been distributed as dividend was not so distributed but kept back by the directors which converted the amount into a " reserve ". On appeal, the Supreme Court held that it was not correct that the directors of the company had kept back the amount, as they had no power to distribute the same but could only recommend distribution thereof as dividend. The Supreme Court noted regln. 99 of the First Schedule of Table A of the Indian Companies Act, 1913, which provided as follows : " The directors may, before recommending any dividend, set aside out of the profits of the company such sums as they think proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for meeting contingencies, or for equalising dividends, or for any other purpose to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n, to keep, as for oneself. 2. To keep back ; to retain or hold over to a future time or place. 3. To preserve'." Mr. Roy next cited another decision of the Supreme Court in First National City Bank v. CIT [1961] 42 ITR 17, where an American banking company following the American system of accounting, conforming to the instructions in Treasury Rules of the U.S.A., transferred balance of its profits to an account headed " Undivided Profits " after making provisions for expenses, taxes, dividends and reserves and under the said Treasury Rules treated the same as part of its capital available for future use in its business. The Supreme Court held that in deciding whether a particular fund constituted a reserve or not the system of accounting followed was relevant. The amount designated as undivided profits though not allocated by a resolution of the directors was still a fund created under the requirement of law which treated it as a part of the capital and, therefore, the same must be considered to be a part of the reserve of the company. Mr. Roy next cited another decision of the Supreme Court in CIT v. Standard Vacuum Oil Company [1966] 59 ITR 685, where sums set apart by a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion of a provision in the Companies Act, 1956, or though it might be held to be a " provision " under the principles of accountancy. The distinction between a reserve and a provision in the Companies Act, 1956, was relevant only for the form of the balance-sheet of a company and for no other purpose. The expression " reserve " was a generic term of wide import and included a " provision " within its ambit. Mr. Roy referred to Pt. III of Sch. VI of the Companies Act, 1956, to show that the distinction drawn between a provision and a reserve was extremely limited in scope. Interpretation " 7. (1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires,--- (a) the expression 'provision' shall, subject to sub-clause (2) of this clause, 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 as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminut ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arry forward any profits which it may think prudent not to divide, without setting them aside as a reserve." Mr. Roy submitted that this regulation indicated that a reserve set apart could be used for any purpose and that a reserve included provisions for meeting contingencies. Mr. Roy next placed the decision of the Supreme Court in Metal Box Company of India Ltd. v. Their Workmen [1969] 73 ITR 53; 39 Comp Cas 410, for the purpose of distinguishing the principles laid down therein. The dispute in that case arose in the computation of bonus payable to the employees in accordance with the Bonus Ordinance in the accounting year ending on 31st March, 1965. The company computed the amount of bonus payable under the said Ordinance by first deducting from its gross profits, various amounts, whereafter the available surplus allocable was determined. It was contended by the workmen that the company had wrongfully reduced the gross profits and, consequently, the available surplus, by deducting from its gross profits provisions respectively for gratuity and doubtful debts. It was not disputed that a sum being the estimated liability under two separate gratuity schemes framed by the comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oprietor's interest (see Spicer and Pegler's Book Keeping and Accounts, 15th edition, page 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision (see William Pickles Accountancy, second edition, p. 192; Part III, clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve.)" Mr. Roy submitted that what the Supreme Court had in fact decided on the facts was that the amounts of estimated gratuity as debited were to be treated as current liability. According to Mr. Roy the Supreme Court also held that the amounts debited could not be a reserve because if it was a reserve it had to be added back while computing the gross profits. It was also not a provision because in terms of the definition adopted by the Supreme Court from the text books of accountancy and the Companies Act, a provision was one of which the amount could not be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tended that the expression would have the same meaning as judicially expounded. (d) In the Expln. to r. 1 of the Second Schedule of the C.(P.)S.T. Act, 1964, it has been added as follows : " Explanation.--For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the, heading 'RESERVES AND SURPLUS' or of any item under the heading 'CURRENT LIABILITIES AND PROVISIONS' in the column relating to 'Liabilities' in the ' FORM OF BALANCE-SHEET' given in Part I of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule. The introduction of this Explanation shows that prior thereto there was some doubt as to the law and that in case of doubt construction of a statute should be in favour of the taxpayer and not of the revenue. The earlier decisions of this court in Braithwaite and Co. (India) Ltd. [1978] 111 ITR 729 (Cal) and Duncan Brothers and Co. Ltd. [ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... taxation : Deduct appropriations : ... General Reserve ... Proposed dividends (gross)-- payable November 30th, 1969 Unappropriated Profit for the year Mr. Sengupta finally submitted that the instant case was covered by the previous decisions of this court in Braithwaite Co. (India) Ltd. [1978] 111I ITR 729 (Cal) and Duncan Brothers Co. Ltd. [1978] 111 ITR 885 (Cal). He drew our attention to the latter case where almost identical submissions had been advanced by Mr. K. Roy on behalf of the assessee which were rejected by the court. The subsequent decision of this court in Burn Co. Ltd. [1978] 114 ITR 565 (Cal), according to Mr. Sengupta, did not assist the assessee in the instant case as it was distinguishable on facts and had also followed the earlier cases. It could not be held that the earlier decision in Braithwaite Co. (India) Ltd. [1978] 111 ITR 729 (Cal) or Duncan Brothers Co. Ltd. [1978] 111 ITR 885 (Cal) was no longer good law. We make it clear at the outset that the judgment in Burn Co. Ltd. [1978] 114 ITR 565 (Cal) creates no difficulty in the instant case. The judgment neither dissents nor differs from the earlier decisions. In fact, it is ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... luses which are not designed to meet any liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet. 2. Provisions are amounts set aside out of profits and other surpluses to provide for : (a) depreciation, renewals or diminution in value of assets, or (b) any known liability of which the amount cannot be determined with substantial accuracy. It follows, therefore, that : 1. Any amount set aside for the purposes described in (2)(a) and (b) (above) in excess of estimated requirements must be regarded as a reserve, and 2. Sums set aside to meet known liabilities of which the amount can be determined with substantial accuracy do not fall within the definition of a provision and should, therefore, be described as accruals or accrued liabilities. Reserves are in effect part of the undistributed profits of the business and, therefore, part of the proprietorship, whereas provisions and accruals are a diminution of proprietorship in the form of a liability or diminution of an asset. The former are broadly appropriations of, the latter charges against, profits." Similar observations also appear in Spicer and Pe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Pt. III of Sch. VI thereto. The contention of Mr. Roy that the definitions of the expressions " reserve " and " provision " in Pt. III of Sch. VI are confined only to the balance-sheet and not to the rest of the Companies Act, cannot be accepted. The definitions in Pt. III of Sch. VI of the Companies Act refer to the form of the balance-sheet which every company has to conform to. It is in the background of a balance-sheet in this form that the directors of a company have to make their report to the shareholders as to the " reserve " of the company under s. 217 of the Companies Act, 1956. The expression " reserve " as introduced in 217 is followed by the words " as in the balance-sheet ". A clear distinction between a reserve and a provision has also been made in regln. 87 of the Companies Act, 1956. In the said regulation, it is specifically, stated that " reserves, " would include " provisions for contingency ". A provision for contingency is a provision for a liability which may or may not occur. Such a provision is not for a known liability the amount of which is ascertainable accurately. By specifically including " provision for contingency " in the expression " reserve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions thereunder, the prescribed form of the balance-sheet, the clauses in Sch. VI of the Companies Act, 1956, contained in Pt. III thereof and the definitions of the expressions " reserve " and " provision ", read with the decision of the Supreme Court in Metal Box Co. of India Ltd.'s case [1969] 73 ITR 53 (SC), leave little room for doubt as to how the expression " reserve " should be construed in the context of the S.P.T. Act, 1963. For the reasons above, following the earlier decisions of this court in Braithwaite and Co. (India) Ltd.'s case [1978] 111 ITR 729 (Cal) and Duncan Brothers Co. Ltd.'s case [1978] 111 ITR 885 (Cal), we hold that the provision for taxation in the present case cannot qualify as a " reserve " within the meaning of r. 1 of the Second Schedule of the S.P.T. Act, 1963. It only remains for us to consider the nature of the other amount of Rs. 11,41,689. Even accepting the contentions of Mr. Roy in their entirety this amount cannot be held to be a " reserve ". After providing for taxation, reserves and dividend this amount was left unappropriated and without being set apart for any purpose. We hold that this amount was unappropriated profits and not rese ..... X X X X Extracts X X X X X X X X Extracts X X X X
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