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TMI Blog1982 (5) TMI 74X X X X Extracts X X X X X X X X Extracts X X X X ..... erused the record of the ITO and found that the order passed by the ITO was erroneous and prejudicial to the interest of the revenue. He, therefore, issued a notice under section 16. The Commissioner stated that the ITO in determining the capital base for arriving at the standard deduction for the year included the debenture stock redemption reserve and the full amount standing in the general reserve account. The inclusion of the sum of Rs. 24 lakhs on account of the debenture stock redemption reserve, was erroneous. He further indicated that the full amount of general reserve, as on 1-1-1974, could not have been considered for inclusion, inasmuch as the proposed dividend of Rs. 24,32,250, for the year 1973, was to be paid from the general reserve. Therefore, the inclusion of the amount was also erroneous. The assessee's representative pleaded before the Commissioner that the general reserve was rightly taken so far as the amount of dividend of Rs. 24,32,250 was concerned. However, on the debenture stock redemption reserve, he stated that the debenture stock redemption reserve as appearing in the balance sheet of the company was not hit by any of the provisions of the Explanation t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the use of the expression 'Reserve', the amounts to the credit of the Debenture Stock Redemption Reserve constitutes really a Reserve. Part III (the interpretation clauses of Schedule VI of the Companies Act) of Schedule VI of the Companies Act throws some light on the matter. Rule 7(1)(b) says that the expression 'Reserve' shall not include any amount retained by way of providing for any known liability. The expression 'provision' is defined in rule 7(1)(a) to mean any amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy. In the circumstances of this case, the provisions of Rs. 6 lakhs out of the profits for the Debenture Stock Redemption Reserve can be said to be a provision towards a known liability arising out of contract. It cannot therefore be treated as 'Reserve' for computing the capital for the purposes of the Surtax Act. The point that the Debenture Stock Redemption Reserve, on re-payment or redeeming the debenture stock would be closed by transfer to the general reserve does not have any special bearing inasmuch as even in a case where there is a Debenture Stock Redemption Reserve Fund or Debenture ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dule 2 on page 4 for reserve and surplus. Referring to these pages, the counsel of the assessee stated that it is evidently clear that the debenture stock redemption reserve has been appropriated out of the profit and the reserve has not been created in the profit and loss account. It was stated that the assessee-company has already issued debentures for which debenture account has been credited and, therefore, the assessee could not have credited the same account by debiting the amount in the profit and loss account. Therefore, the reserve created by the assessee was only out of the surplus profit. The reserve did not create any charge on the profit of the assessee. He also referred to Schedule II to the Act, the Companies Act, 1956 and Clause 7 of Part III of Schedule VI to the Companies Act, 1956 and stated that if these provisions are taken into consideration, the debenture stock redemption fund was only a reserve, and therefore, the ITO was justified in not excluding the amount. He further referred to the Balance Sheet and urged that the general reserve is to be taken as it was on 1-4-1974, whereas the dividend pertained for the year 1973 and, therefore, the ITO was justified ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... use 6(a) of the trust deed the debenture stock was secured against the hypothecation of specified shares held by Shaw Wallace in certain companies (specified in the Second Schedule to the trust deed) and further a charge was created in favour of the trustees of the undertaking and assets of Shaw Wallace (excluding the specified shareholdings hypothecated). Subject to all existing mortgages, pledges and hypothecations, the charge, in respect of the undertaking and its other property and assets, was to rank as a floating charge and was in no way to hinder or prevent Shaw Wallace from selling, mortgaging, charging, leasing, or otherwise disposing of, or dealing with, such assets (other than fixed assets), in the ordinary course of its business. The conditions to be endorsed on the stock certificate have been set out in clause 45 of the trust deed. Inter alia, a condition is that during the financial year ending 31-12-1970 and during every succeeding financial year while the stock, or any part thereof, remaining outstanding, the company shall out of its divisible profits (as defined in the trust deed) have to set apart annually, a sum of Rs. 6 lakhs and credit such sum to a reserve to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s neither erroneous nor prejudicial to the interest of the revenue. The points in issue are two: Whether general reserve would have been diminished by Rs. 24,32,250 and Rs. 24,00,000 for dividend and debenture stock redemption reserve. So far as the proposed dividend of Rs. 24,32,250 is concerned, the inclusion of this amount in the capital base by the ITO is erroneous in view of the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. Consequently, the action of the Commissioner on this issue is maintained. 9. The only other point is whether the Commissioner was justified in directing the ITO to exclude Rs. 24,00,000 from the capital base. The main controversy is whether the reserve created by the assessee for the debenture stock redemption reserve was a reserve or it was a provision. Whether a particular sum is a reserve or a provision could only be determined by applying the principles of accountancy. William Pickles in Accountancy (Fourth Edition) at pages 0717---0718 describes reserves and provisions as follows : "The lack of uniformity and looseness in the past in the employment of the term 'reserve' have tended not only to create confusion in the mi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually 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." Further, the reserve and provision have also been dealt with in clause 7 of Part III of Schedule VI of the Companies Act, 1956 which are as follows: "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, means 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 diminution in value of assets or retained by way of providing for any known liability ; ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ss receipts in the profit and loss account, a 'reserve' is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business. Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53 ; 39 Comp. Cas. 410 (SC) followed. Though the term 'provision' is defined in clause 7 of Part III of Schedule VI to the Companies Act, 1956, positively by specifying what it means, the definition of 'reserve' is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term 'reserve'. The effect of reading the two definitions together is that if any retention or appropriation of a sum falls within the definition of 'provision' it can never be a reserve, but it does not follow that if the retention or appropriation is not a provision it is automatically a reserve and the question will have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation has been made, because the substance of the matter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 127 ITR 47 (Guj.). If the principles of reserve as laid down in the Accountancy Books, as stated above, as well as the guidelines prescribed by the Hon'ble Supreme Court in Vazir Sultan Tobacco Co. Ltd. are taken into consideration, the debenture stock redemption reserve created by the assessee was only a reserve. This conclusion is based upon the following facts: (i) Creation of debenture stock redemption reserve had been recommended by the Directors in their report (page 1 of the assessee's paper book). (ii) The 'reserve' has been created out of the surplus profit of the assessee (page 2 of the paper book). (iii) The 'reserve' has been created in the Profit and Loss Appropriation Account (page 3 of the paper book). (iv) The 'reserve' has not been created in Profit and Loss Account (page 3 of the paper book). (v) The 'reserve' so created by the assessee has not diminished the assets of the assessee. (vi) The 'reserve' created by the assessee is appearing as 'reserve' under the head 'Reserve and Surplus' in the Balance Sheet of the assessee. (vii) The 'reserve' as appearing in the Balance Sheet is in accordance with the requirements of Part I of Schedule VI of the Com ..... X X X X Extracts X X X X X X X X Extracts X X X X
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