9911796707
TMI Blog1993 (12) TMI 85X X X X Extracts X X X X X X X X Extracts X X X X ..... & French Corporation and the Indian company named Eskayef (Pvt.) Ltd., was incorporated in India on 1-11-1983 as a 100% subsidiary of the U.K. company M/s. Eskaylab Ltd. Earlier, Eskaylab Ltd., was having its entire business of the nature of manufacture and sale of pharmaceutical products in India only. However, its Indian branch comprising the entire business in India was amalgamated with the abovementioned Indian company viz., Eskayef (Pvt.) Ltd., on 11-2-1985 with effect from 1-12-1983. Eskayef (Pvt.) Ltd., later on became a public limited company and was known as Eskayef Ltd. 2.1 Thus during all the four years under consideration, it was the U.K. company viz., Eskaylab Ltd. [Smith, Kline, French (India) Ltd. till 1981] which carried on the Indian business and was also required to be assessed accordingly. The returns of chargeable profits for assessment year 1980-81 was filed in the name of Smith, Kline, French (India) Ltd., and for the other three years by Eskaylab Ltd. The assessments were, however, done by the Assessing Officer in the name of M/s. Eskayef Ltd. These assessments were however accepted by the assessee and appeals were also filed by the assessee against the abo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ut that in the original assessments made by the Assessing Officer, the "capital" of the assessee-company was computed by taking into consideration the amounts of share capital as well as reserves as shown in the balance-sheet of the assessee-company at UK in terms of Sterling Pound. In the said original assessments, the Assessing Officer had accepted the plea of the assessee about inclusion of the different items of reserve shown in the said balance sheet viz., Investment allowance reserve, development rebate reserve and other reserves. "Other reserve" on the other hand, comprised of unappropriated profits brought forward and re-instatement of capital expenditure on scientific research, after making due adjustment for taking into consideration the profit/loss for the year (actually the earlier year). The learned counsel for the assessee has drawn our attention to the notice issued by the CIT regarding the proceeding under section 16(2) wherein it was stated that the surplus as well as the unappropriated profits should not have been included within "reserves" for the purpose of computation of capital. He has argued that this statement made by the CIT in the notice under considerati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of surplus in rupees as shown in the branch accounts of the company in India. The CIT furthermore stated that the assessee had claimed certain amounts of capital expenditure on scientific research during all these years and that such amounts had been allowed in the Income-tax assessments under section 35(ii). The same amounts were stated by the CIT to have been debited by the assessee in its profit and loss account and simultaneously transferred to the general reserve every year. These amounts were also included in the computation of capital base by the Assessing Officer. The CIT stated thereafter that these amounts were not to be considered as reserves includible within the computation of capital inasmuch as these amounts had actually been allowed as expense in the respective income-tax assessments. He thus came to the conclusion that the assessment orders as passed by the Assessing Officer had been erroneous and also prejudicial to the interests of revenue. Ultimately therefore, the CIT stated--- "Hence, the assessment orders are SET ASIDE with a direction to the Assessing Officer to make fresh assessments according to law as mentioned above." 3.2 The learned counsel for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssee stated before us that this was a ridiculous position inasmuch as the assessee would be expected to get the benefit of at least the amount of share capital in the computation of capital base for surtax purpose if not any portion out of the reserves. He thus argued that the abovementioned facts clearly show that the CIT passed the impugned order under section 16(2) without fully understanding and appreciating the facts of the case and without applying his mind. He thus contended that the impugned order of the CIT is required to be struck down and quashed fully on this ground alone. 3.3 Regarding the merits of the case, the learned counsel for the assessee contended that one of the items tried to be hit by the CIT is unappropriated profits included within "other reserves". He contended that although in India it is not possible to treat unappropriated mass of profit as a part of the "reserve" for the purpose of computation of capital base, in UK however, the position is completely different. It has been stated that in accordance within the UK Companies Act and generally accepted UK accounting practice, the retained profit at the end of each year is carried forward as a reserve an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... having no effect. He thus argued that the ITAT's observations in this regard are not to be considered as binding. He strongly contended that a reserve of this type is not created by crediting to the reserve any amount which has actually been allowed as a deduction in the computation of income of the company and hence these reserves will not fall within the ambit of the excluding provisions of sub-clause (iii) of clause (1) of the Second Schedule to the Surtax Act. On the other hand, his argument was that only such reserve, the creation of which alone renders the amount credited liable to be deducted from the computation of total income as in the case of special reserve envisaged in section 36(1)(iii) should fall within the mischief of this particular provision. In any case, he also argued that on the first day of the next accounting year (on which date alone the capital base is computed) the reserve of this type created in the accounts for the earlier year does not have any separate existence and gets merged with the other reserves, and hence there is no scope for excluding this reserve from the computation of capital base. Alternatively, he contended that at best the amount charge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ow the wrong direction to which the CIT led his mind and not that the CIT did not allow his mind to be led to any direction at all and passed the order merely on the spur of the moment. This order can at best be called to be the product of misapplication of mind on the part of the CIT and not dis-application meaning total absence of application of mind. An order passed on the basis of mis-application of mind is subject to appellate scrutiny but does not become bad in law and hence quashable on the ground of natural justice. We, therefore, hold that the argument put forward by the learned counsel for the assessee that the order passed by the CIT is required to be quashed at the outset on account of lack of application of mind on his part is not at all tenable. So far as the validity of the order from this aspect is concerned, we uphold the order. 5. However, now it will be our task to go through the merits of the case and try to find out whether the discussions made and the directions given by the CIT can be considered to be in the right way. We will also have to see now whether, the orders passed by the Assessing Officer which have, in fact, been sought to be revised by the CIT th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... That was a case of a banking company incorporated in USA. It was held therein that in their very nature the "undivided profits" were accumulation of amounts of residue on hand at the end of the year of successive periods of accounting and these amounts were by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company, for the purpose of excess profits tax. It may be mentioned in this connection that the computation of capital base under the Excess Profits Tax Act was similar to that under the Surtax Act. The Supreme Court also extended in the case of Standard Vacuum Oil Co. the above proposition relating to includibility of the surplus within "reserve" for the purpose of computation of capital base under the Excess Profits Tax Act even though this was not a case of the banking company and that the assessee in that case was not required to maintain its accounts in any particular way as per the directions of the Treasury. The Supreme Court stated in this case that the "earned surplus" could not be regarded as mere un-allocated profits so as not to represent "reserves" within the meaning of rule 2. 5.3 The Patna High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uditor viz. KPMG Peat Marwick dated 7-10-1991 to the Directors of the assessee-company in which it has specifically been stated that in accordance with the UK Companies Acts and generally accepted UK accounting practice, the retained profit at the end of each year is carried forward as a reserve and that there is no requirement for a formal resolution of the directors or shareholders to transfer an amount to reserves in order for it to become a reserve. The auditors also clearly stated that this treatment is similar to that adopted under US generally accepted accounting practice whereby the undistributed profits of each year are added to reserves and are carried forward from year to year within reserves. 6. Even when we look at the UK accounts of the assessee-company, we find that the abovementioned version of the auditors of the assessee-company appears to be very much true. The balance-sheet of the company shows only other reserves in addition to investment allowance and development rebate reserve. The break-up of this other reserves alone shows the component items like unappropriated profits brought forward and reinstatement of capital expenditure on scientific research. Like I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Act, 1961...." We are of the opinion that the amounts representing capital expenses on scientific research cannot be considered to have been allowed as a deduction in computing the income of the company for the Income-tax Act. This should be clear from the consideration of the entries those are generally made with regard to incurring of capital expenditure on scientific research. 7.1 The general entry which is made by all assessees with regard to expenses of this type is as follows : "Debit asset account (on scientific research) Credit cash or bank account" In addition to the above entry, in the instant case, the assessee appears to have passed another entry also as below: "Debit profit & loss account, and Credit general reserve account." The amount concerned in both the entries is the same. Ultimately, however, this general reserve amount is passed on from Indian accounts to the UK accounts of the assessee-company and it forms a part of its "other reserves" in the UK account. 7.2 It may thus be seen from above that what has been allowed in computation of the income of the assessee for income-tax purpose is the amount debited to the asset account which alone represents the ..... 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