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TMI Blog1974 (4) TMI 30X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee as "reserves" within the meaning of rule 1 of the Second Schedule to the Act. The Commissioner of Income-tax in exercise of his powers under section 17(1) of the Act set aside the order of the Income-tax Officer. The Commissioner passed his order on 31st July, 1968. The Commissioner took the view that the surplus profits and the provision for proposed dividend were not includible for the standard deduction. For this view support was derived from Commissioner of Income-tax v. Century Spinning and Manufacturing Company Ltd. Thereafter, the Income-tax Officer passed a fresh order on 10th November, 1968. The assessee then preferred an appeal to the Appellate Assistant Commissioner, who, by his order dated 11 th of August, 1969, confirmed the order of the Income-tax Officer. The assessee being dissatisfied with the order of the Appellate Assistant Commissioner preferred an appeal to the Income-tax Appellate Tribunal. Two matters were agitated before the Tribunal that, (a) the surplus profit amounting to Rs. 7,02,001, and (b) the proposed dividend amounting to Rs.8,64,961, should have been held to be a "reserve" and not a "mass of undistributed profits". Therefore, the e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing and Manufacturing Co.'s case want us to understand. This is the kind of a 'reserve' which their Lordships had in their mind when they held against the assessee in Century Spinning and Manufacturing Co.'s case because they were of the view that the proposed dividend merely earmarked continued to be a mass of undistributed profits but they have been given a definite shape; they have been given a definite treatment, they have been specifically provided to be a reserve for a specific purpose and, therefore, is a 'reserve'. We are, therefore, of the view that the authorities below were not right in treating the proposed dividend of Rs.8,64,961 as a mass of undistributed profits and not a reserve and hold that the proposed dividend constituted a reserve within the meaning of Schedule II of the Super Profits Tax Act." The result was that the Tribunal partly allowed the appeal of the assessee. The assessee was satisfied with the order of the Tribunal with regard to the amount of Rs. 7,02,001, but the department was not satisfied with the decision of the Tribunal with regard to the proposed dividend being held as a reserve within the meaning of the rule. The Commissioner of Income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the standard deduction, at the rate or rates specified in the Third Schedule." The Second Schedule to the Act contains rules for computing the capital of a company for the purposes of super profits tax. These rules have been framed under section 2(9) of the Act. In the instant case, we are only concerned with rule 1. The relevant part of this rule is in the following terms: "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 reserves, 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)..." This rule talks of two types of "reserve". It i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "Payment of a final dividend at the rate of Rs. 18 per share (making Rs. 28 per share for the whole year) free of income-tax absorbing.... Rs. 4,92,426-0-0 Balance to be carried forward to next year's account.......... Rs. 16,211-6-8" This recommendation was accepted by the shareholders in their meeting on the 3rd April, 1946. The dividend was made payable on the 15th of April, 1946, and was actually distributed. On these facts, the question was posed whether the amount of Rs. 5,08,637 could be called a "reserve". Their Lordships then gave the dictionary meaning of the term "reserve" and thereafter observed : "What is the true nature and character of the disputed sum must be determined with reference to the substance of the matter and when this is borne in mind, it follows that on the 1st of April, 1946, which is the crucial date, the sum of Rs. 5,08,637 could not be called a 'reserve' for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on the 28th February, 1946, the directors clearly earmarked it for distribution as dividend and did not choose to make it a reserve. Nor did the company ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e undistributed profits of the company, remained unaltered. Thus, the profits lying unutilized an not specially set apart for any purpose on the crucial date did not constitute reserves within the meaning of Schedule II, rule 2(1). Reference was made to sections 131(a) and 132 of the Indian Companies Act. Section 131(a) enjoins upon the directors to attach to every balance-sheet a report with respect to the state of the company's affairs and the amount, if any, which they recommend to be paid by way of dividend and the amount, if any, which they propose to carry to the reserve fund, general reserve or reserve account. The latter section refers to the contents of the balance-sheet which is to be drawn up in the Form marked F in Schedule III. This form contains a separate head of reserves. Regulation 99 of the 1 st Schedule, Table A, lays down 'that 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 which the profits of the company may ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... distribution in the same year as dividend is destructive of making them a reserve. If this distinction is kept in view, the decision of the Supreme Court presents no difficulty, and its ratio becomes clear. Mr. Dastur, however, would insist that all that was required to create a reserve was a bifurcation of the amount from the mass of general profits and patting it under a separate head. We are unable to accept this contention and, in our opinion, it is not justified on the plain and true reading of the decision of the Supreme Court in Century Co.'s case. In fact, the observations made by their Lordships of the Supreme Court, after referring to sections 131 (a) and 132 of the Indian Companies Act, clearly show that when a reserve is being created, the directors should apply their mind in that behalf. On the contrary, when the directors reserved the amount in question for distribution as dividend, they clearly took this amount out of the category of "reserve". That is why their Lordships were at pains to stress that the amount was actually distributed as dividend after the general meeting had adopted the proposal made by the directors in that behalf. If the mere earmarking of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... matter and were side-tracked. The view we have taken of the matter has been adopted by the Allahabad High Court in Commissioner of Income-tax v. Hind Lamps Ltd., This is a case under the Super Profits Tax Act, 1963. The assessee claimed that the amount of proposed dividend be included in the computation of capital. It was held that the amount of proposed dividend could not be included in the computation of capital under the Super Profits Tax Act. To constitute a "reserve", the amount must be specifically kept apart for future use or for a specified occasion. It will be useful to quote the observations of the learned judges in this case : "Turning to the facts before us, it seems that the item of Rs. 4,17,500 representing proposed dividends cannot be treated as a reserve. It appears that the board of directors of the assessee made a proposal to the shareholders that the amount be distributed among the shareholders by way of dividends and made a provision for that amount in the balance-sheet of the year ending December 31, 1961. Apparently, therefore, the amount was earmarked for payment of dividend and was not treated by the directors as reserve. So far as this item is concer ..... X X X X Extracts X X X X X X X X Extracts X X X X
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