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TMI Blog1996 (2) TMI 130X X X X Extracts X X X X X X X X Extracts X X X X ..... certificate granted on December 12, 1977, by the Gujarat High Court arise out of its judgment and order dated June 21, 1977, in Income-tax Reference No. 6 of 1976. The Commissioner of Income-tax, Gujarat, is the appellant while the assessee company is the respondent. The Income-tax Appellate Tribunal, Ahmedabad, referred the following question for the opinion of the High Court of Gujarat under section 18 of the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as "the Surtax Act"), read with section 256(1) of the Income-tax Act, 1961 : "Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that reserve for doubtful debts and gratuity reserve created by the assessee were includible in computing the capital for the purpose of computing statutory deduction ?" However, the Division Bench of the High Court by consent of the parties refrained the question as under : "Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that rehabilitation reserve, reserve for doubtful debts and gratuity reserve created by the assessee were includible in computing the capital for the purpo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the Revenue, the aforesaid question was referred to the High Court, which as stated earlier, was reframed by the High Court. We shall first deal with the question regarding the inclusion of Rs. 85,000 sought to be treated as reserve for meeting doubtful debts in the capital base of the respondent-company. So far as this reserve is concerned, as noted earlier, the Appellate Assistant Commissioner as well as the Tribunal relied upon the assessments for the earlier years for the very same respondent-company for holding this reserve as includible in the capital base. The High Court also followed suit. In our view no exception can be taken to the aforesaid view of the High Court. The reasons are obvious. As noted by the Income-tax Appellate Tribunal in the present proceedings, it had already taken a similar view by its earlier order dated August 19, 1973, while considering the question of computation of the capital base of the respondent-assessee-company itself for the previous years. The pertinent observations are found at page 25 of the paper book : " So far as reserve for doubtful debts is concerned, ordinarily the provision for doubtful debts is created with reference to the s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the assessee by Shri Salve that this was created by transfer from the appropriation account and not as a charge against profit. Furthermore, a separate provision was made for bad and doubtful debts which provision was reduced from the value, of the assets. It was not the Revenue's case that the provision for bad and doubtful debts provided was less than the amount reasonably necessary to be provided. If the amount, as it appears to be, is more than the amount reasonably necessary to be provided in respect of bad and doubtful debts, then it constituted a 'reserve'. It is not correct to state that by the very nomenclature, this was not a reserve. The true nature of the transaction has to be examined." At page 746 of the Report applying the aforesaid principles to the case on hand, it was held that in the light of the facts found so far as bad and doubtful reserves were concerned the amounts set apart must be treated as a reserve. On the facts of the present case, as noted earlier, it could not be said that there was any ascertained liability for which a provision was made by creating the aforesaid reserve for bad and doubtful debts. In the present case, it was also not the Revenu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rent. The amount standing to the gratuity reserve for the year ended 31st December, 1966, was transferred to the general reserve account. This was merely a reserve, which was kept back for future years without reference to any ascertained liability. The said amount in any case would be includible in computing the profits of the company. We, therefore, hold that, on the facts of the case, the contention canvassed by the assessee that the impugned amount be treated as a reserve for inclusion in the capital base has to be accepted. We, therefore, accordingly, direct the Income-tax Officer to include the aforesaid amount in the computation of capital base of the company." The aforesaid view of the Tribunal has been accepted by the High Court. Learned counsel for the Revenue vehemently submitted that so far as this aspect is concerned, it was assumed that merely because the assessee-company had not thought it fit to resort to any actuarial valuation and had styled the amount as forming part of a reserve, almost automatically the Surtax Officer had to treat the said amount as set apart by way of a reserve and not a provision. That this would amount to giving complete lat itude to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lly shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor'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, page 192 : Part III, clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve)." The aforesaid decision was relied upon by a three member Bench of this court consisting of V. D. Tulzapurkar, E. S. Venkataramiah and Amarendra Nath Sen JJ., in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559. In that case, this court was concerned with a similar question which is posed for our consideration in the present proceedings. Amongst other questions on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er of years of service put in by him and the liability accrues and enhances with the completion of every year of service ; but the company can work out on an actuarial valuation its estimated liability (i.e., discounted present value of the liability under the scheme on a scientific basis) and make a provision for such liability not all at once but spread over a number of years. It is clear that if by adopting such scientific method any appropriation is made such appropriation will constitute a provision representing fairly accurately a known and existing liability for the year in question ; if, however, an ad hoc sum is appropriated without resorting to any scientific basis such appropriation would also be a provision intended to meet a known liability, though a contingent one, for, the expression 'liability' occurring in clause 7(1)(a) of Part III of the Sixth Schedule to the Companies Act includes any expenditure contracted for and arising under a contingent liability ; but if the sum so appropriated is shown to be in excess of the sum required to meet the estimated liability (discounted present value on a scientific basis) it is only the excess that will have to be regarded as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat if the discounted present value of gratuity liability on a scientific basis was arrived at by the assessee-company by resorting to actuarial valuation of such liability it would have supplied a basis for the Surtax Officer to compute the capital base by treating the said amount as a provision and that if it was further found that the amount set apart for meeting such liability was in excess of such provision then the excess amount could have been determined for being included as a reserve in the capital base. But, in the absence of the assessee-company undertaking such an exercise, it was not as if the Surtax Officer was helpless or was necessarily required to accept as gospel truth what the assessee submitted for treating the entire amount set apart as a reserve.The Surtax Officer under such circumstances could have legitimately resorted to an estimate for ascertaining the extent of provision for such contingent liability for gratuity required to be met by the assessee-company in the concerned assessment years. It would have been equally open to the Surtax Officer to call upon the assessee-company to get actuarial valuation of such liability to enable the Surtax Officer to com ..... X X X X Extracts X X X X X X X X Extracts X X X X
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