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TMI Blog1978 (1) TMI 55X X X X Extracts X X X X X X X X Extracts X X X X ..... r Profits Tax Officer observed that it was clear that the first five items had been set apart for specific purposes already known. He, therefore, held that each of the above items were meant to be used for a specific contingency already foreseen, though not yet quantified, otherwise, those would have all been put in the general reserve account already maintained by the assessee. As these amounts had been specifically set apart and earmarked to meet particular liabilities and nothing else, none of these could be called a reserve within the meaning of the Second Schedule of the Super Profits Tax Act, 1963. He also considered the other four items and was of the opinion that those were also of the same nature as the earlier five items, though these had been designated as " reserve " instead of as " provision ". He observed that when one looks to the substance and nature of these funds it became clear that each of them was designated to meet a liability, contingency, commitment or diminution in the value of the assets known to exist as at the time of the balance-sheet. The Super Profits Tax Officer, therefore, came to the conclusion that the could not be called " reserve " within the me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... these were against liabilities not quantified or ascertained and, hence, these constituted reserves within the meaning of the provisions of the Second Schedule of the Super Profits Tax Act, 1963. The Tribunal, therefore, allowed the assessee's appeal in part and dismissed the revenue's appeal. On an application being made to the Tribunal under section 256(1) of the Income-tax Act, 1961, read with section 19 of the Super Profits Tax Act, 1963, the Tribunal has referred the following question to this court : " Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the items styled as provision for P.I. bonus, provision for bonus and taxation contingency reserve should be treated as ' reserves ' for computing the capital of the assessee-company for the purposes of super profits tax under the Super Profits Tax Act, 1963 ? " It may be mentioned that a statement had been filed before the Appellate Assistant Commissioner explaining the several items and, in respect of the three items with which we are concerned in this reference, it was stated as follows : " (1) Provision for provident institution long service bonus Rs. 1,02,200. This ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... puting the capital of a company for the purposes of super profits tax. We have noticed that under sub-section (9) of Section 2, standard deduction for computation of the profit for super-tax was 6% of the capital of the company. The rules in the Second Schedule were meant to compute the capital of the company for the purpose of making the standard deduction. Rule 1, with which we are concerned in this reference, so far as is material for our present purpose, was as follows : " 1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the sum of the amounts, as on the first day of the previous year relevant to the assessment year, of its paid up share capital and of its reserve, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the Indian Income-tax Act, 1922 (11 of 1922), or under sub-section (3) of section 34 of the Income-tax Act, 1961 (43 of 1961), and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961), diminished by the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... puting the profits of the assessee for the purposes of income-tax. In February, 1946, the directors of the company recommended that out of the amount a sum of Rs. 4,92,426 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 3rd April, 1946, and the amount was shortly afterwards distributed as dividends. In computing the capital of the assessee-company on 1st April, 1946, under the Business Profits Tax Act, 1947, the assessee claimed that the sum of Rs. 5,08,637 and the profit earned by it during the period 1st January, 1946, to 1st April, 1946, should be treated as " reserves " for the purpose of rule 2(1) of Schedule II. The High Court of Bombay held that the sum of Rs. 5,08,637 must be treated as a reserve for the purpose of rule 2, but the profits made by the assessee during the period 1st January, 1946, to 1st April, 1946, could not be included in the reserves. There was an appeal to the Supreme Court ([1953] 24 ITR 499) and the Supreme Court held that the sum of Rs. 5,08,637 and the profits earned by the assessee during the period 1st Janua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reference to the substance of the matter. Then, at page 24 of the present report, their Lordships quoted from the judgment of the report of the Supreme Court in [1953] 24 ITR 499 (SC) at page 504, as mentioned before but the same was really a quotation from the judgment of the Bombay High Court. But it is clear that the said observations of the Bombay High Court were adopted as the ratio of the Supreme Court judgment in the case of Commissioner of Income-tax v. Century Spg. Mfg. Co. Ltd. [1953] 24 ITR 499 (SC) as was understood by the subsequent decision of the Supreme Court in the case of First National City Bank v. Commissioner of Income-tax [ 1961] 42 ITR 17. In the case of Commissioner of Income-tax v. Standard Vacuum Oil Co. [1966] 59 ITR 685, the Supreme Court had to consider, inter alia, whether " capital paid in surplus " and " earned surplus " were reserves within the meaning of rule 2(1), Schedule II. of the Business Profits Tax Act, 1947. The Suprerme Court held that " capital paid " and " earned surplus " were reserves within the meaning of the rule. The Supreme Court noted that the ordinary meaning of the expression " reserve " meant something specifically kept apa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the amount set aside for the last mentioned purpose in excess of estimated requirements must be regarded as reserve and sums set aside to meet known liabilities of which the amount can be determined with substantial accuracy did not fall within the definition of " provision " and should, therefore, be described as accruals or accrued liabilities. In the book, Guide to Company Balance-Sheets Profit and Loss Accounts by Frank H. Jones, sixth edition, in Chapter IX, at page 232, " provision " and " reserve " have been contrasted. Reference has been made to the report of the Cohen Committee in England in 1945, where " reserve " has been stated to be as any amount which, having been set aside out of revenue or other surpluses, are free in that they are not retained to meet any diminution in value of assets, specific liability, contingency or commitment known to exist at the date of the balance-sheet. In the Companies Act, 1956, the form of the balance-sheet also provides that " reserve " has to be separately indicated from " provision " Part III, rule 7(1)(a) and rule 7(1)(b) of Schedule VI of the Companies Act, 1956, defines both " provision " and " reserve ". But the said definition ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssets in respect of which they were made whereas general reserves often would be shown as a part of the proprietor's interest. 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 was a reserve but an amount set aside out of Profits and other surpluses to provide for any known liability of which the amount could not be determined with substantial accuracy was a " provision " (underlined by us). Reference in this connection was made by the Supreme Court to William Pickles' Accountancy, second edition, page 192, as well as to Part 3, clause 7, Sixth Schedule, to the Companies Act, 1956, which defined provision and reserve. In that case, as the Supreme Court was dealing with the question of bonus, the Supreme Court had observed that the Second Schedule of the Payment of Bonus Act, 1965, required the adding back to the net profit shown in the profit and loss account the amount of depreciation deducted in that account while computing the gross profit. In the instant case, a fundamental question has been urged in the sense, whether in considering ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... upreme Court in the subsequent decision in First National City Bank v. Commissioner of Income-tax [1961] 42 ITR 17 (SC) referred to hereinbefore. In the case of Metal Box Company of India Ltd. v. Their Workmen [1969]. 73 ITR 53, the Supreme Court was not considering the use of the expression " reserve " in the context of either of the Business Profits Tax Act, 1947, or the Super Profits Tax Act, 1963. Furthermore, when the Super Profits Tax Act, 1963, was enacted, Parliament had the pronouncement of the Supreme Court on the basis of the Business Profits Tax Act, 1947, using the same expression " reserve " in the same context as enunciated by the Supreme Court in the case of Commissioner of Income-tax v. Century Spg. and Mfg. Co. Ltd. [1953] 24 ITR 499, 504. Therefore, it is legitimate to think that, having had the advantage of judicial exposition of that view, Parliament used the same expression " reserve " and also eliminated the amounts credited for such reserve which had not been allowed in the computation of profits for the purpose of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961, and, therefore, wanted that the expression " reserve " would continue to have the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8] 111 ITR 729 (Cal). a Division Bench of this High Court had occasion to consider whether the provision for taxation for proposed dividend and provision for bonus be considered to be " reserve " within the meaning of rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, for the purpose of computing the capital of the assessee. Mr. Justice A. N. Sen, who delivered the judgment, exhaustively considered the points and referred to several decisions. Mr. justice A. N. Sen has referred to the ratio of the Supreme Court decision in the case of Commissioner of Income-tax v. Century Spinning Manufacturing Co. Ltd. [1953] 24 ITR 499 and, referring to the observations of the Supreme Court made at page 504 of the report, has observed that the expression " reserve " which was used in rule 2 could only mean the profit earned by a company and not distributed as dividends to the shareholders but kept back by the directors for the purposes which might be put to use in future. Analysing the facts the Division Bench found that provision for proposed dividend in that case could not be considered to be reserve in terms of the aforesaid rule. The court further held that provision for taxa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s also drawn to the observations of the court in the case of Vazir Sultan Tobacco Co. Ltd. v. Commissioner of Income-tax [1974] 96 ITR 248 (AP), Hyderabad Asbestos Cement Products Ltd. v. Commissioner of Income-tax [1976] 105 ITR 822 (AP) [FB], Commissioner of Income-tax v. Century Spg. Mfg. Co. Ltd. [1977] 108 ITR 431 (Bom) and also Commissioner of Income-tax v. Security Printers of India (P.) Ltd. [1972] 86 ITR 210 (All). It is not necessary, in the context of the particular controversy we are discussing, to refer to these decisions in detail. We must, however, note another decision of the Bombay High Court in the case of Shree Ram Mills Ltd. v. Commissioner of Income-tax [1977] 108 ITR 27 (Bom). Mr. Justice Tulzapurkar, speaking for the Division Bench, pointed out thus : (i) a mass of undistributed profits cannot automatically become a " reserve " for the purpose of rule 1 of Schedule II of the Super Profits Tax Act, 1963, and somebody possessing the requisite authority must clearly indicate that the amount has been separated from the general mass of profit with a view to constitute it as a reserve ; (ii) it should be apparent from the surrounding circumstances that the am ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tradistinction to " reserve " but not mere possibility of an obligation which has not matured into a liability. See the observation in the case of Commissioner of Income-tax v. Forbes Forbes Campbell Co. Ltd. (1977] 107 ITR 38 (Bom). Now, here one item is taxation contingency reserve. This is not a provision for taxation of the year in question but following prudent financial policy the estimated tax saving for claiming the initial and double depreciation have been set aside in this reserve. There was no known liability for this account. Therefore, in our opinion, the Tribunal was right in considering that this should not be taken as " provision " and, therefore, should be considered as " reserve ". The other item was provision for bonus. Bonus was payable after the annual general meeting of the company and also after settlement had been arrived at by and between the company and the union. There was no statutory liability for bonus. In the case of Commissioner of Income-tax v. Swadeshi Cotton Flour Mills P. Ltd. [1964] 53 ITR 134, the Supreme Court observed that an employer who followed the mercantile system of Accounting incurred a liability towards profit bonus only when the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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