Brij Mohan Thapar vs Commissioner of Wealth Tax

Ajit K. Sengupta, J.—In this reference u/s 27(1) of the Wealth-tax Act, 1957 (''the Act'') the following questions of law have been referred by the Tribunal for the assessment year 1980-81:

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the transfers to the reserve forbad and doubtful debts and advances were not to be taken into account in calculating the maintainable profits of Karam Chand Thapar & Bros. Ltd.?

Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that deposit made under the Compulsory Deposit Scheme (income tax Payers) Act, 1974 is includible-in the net wealth of the assessee?

Shortly stated, the facts, inter alia, are that the assessee, an individual, showed in the return of wealth the value of unquoted 399 shares of Karam Chand Thapar & Co. Ltd., an investment company, as on the valuation date being 31-3-1980 at Rs. 1,911 per share. The WTO while determining the value of the said shares applied the yield method prescribed by the Board in its Circular No. 332A, dated 31-3-1982, in 135 ITR (St.) 12. However, in determining the value by the said method the WTO added back, inter alia, the reserve for bad and doubtful debts and advances for the purpose of arriving at maintainable profits.

In appeal before the Commissioner (Appeals), the assessee challenged such disallowance of the deduction. The Commissioner (Appeals), however, upheld the WTO''s action. Being aggrieved, the assessee came in appeal before the Tribunal. The Tribunal found that on identical facts the order of the Commissioner (Appeals) in the assessee''s case for the assessment year1979-80 stood approved by the Tribunal ruling out any scope for interfering with the order under appeal. Thus, the appellate order of the Commissioner (Appeals) was upheld by the Tribunal.

Another point raised by the assessee before the Tribunal was that deposit under (CDS) should not have been included in the total wealth of the assessee. The Tribunal held that this point did not arise out of order of the Commissioner (Appeals). The Tribunal further observed that in view of the order of the Tribunal for the assessment year 1979-80 and that of Special Bench in the case of Smt. Sushilaben A. Mafatlal v. WTO [1986] 18 ITD 189 (Bom.), CDS deposit has to be included in the total wealth of the assessee. The Tribunal, accordingly, dismissed both the assessee''s and revenue''s appeals.

The second question relating to the includibility of the deposit under the CDS is concluded by the decision of this Court in the case of Smt. Vintta Devi Singhania v. CWT [Matter No. 1158 of 1984, dated 18-2-1991]. Following the said decision we hold that CDS deposit is includible in the total wealth of the assessee. We, therefore, answer the second question in the affirmative and in favour of the revenue and against the assessee.

With regard to the first question, the learned counsel, Dr. Pal, appearing for the assessee contended that there being consensus between the parties that the yield method, as prescribed by the Board in its Circular No. 332A dated 31-3-1982 (supra) should apply, there cannot be any manner of doubt as to the deductibility of the reserve for bad and doubtful debts in arriving at the maintainable profits of the company, whose shares are being valued. According to him, the said circular holds that in the case of a company, which is a going concern and whose shares are not quoted in the Stock Exchange, the profit which the company has been making and should be capable of making or, in other words, the profit-earning capacity of the company, would ordinarily determine the value of its shares. He, further, pointed out that the circular requires that in determining the profit-earning capacity of the company the book profits of the company for the five years immediately preceding the valuation date have to be ascertained and certain adjustments are to be made in respect of such book profits, as laid down in para 4 of the said circular.

It is well-settled as a result of the decision of the Supreme Court in the case of Commissioner of Income Tax, Kanpur Vs. Saran Engineering Co. Ltd, that the amount which is reasonably necessary to be provided in respect of bad and doubtful debt is to be treated as a provision which will be allowed as an outgoing in the computation of profit as understood in the commercial sense. But if the amount is more than the amount reasonably necessary to be provided in respect of bad and doubtful debt, the excess amount is not a provision but a reserve.

He has also relied upon the decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, that a provision is a charge against the profits to be taken into account against the gross receipts in the profit and loss account and a reserve is an appropriation of profit, the asset or assets by which it is represented being retained to form part of the capital employed in the business.

It is his contention that judged by the above test, the provision for bad and doubtful debt was debited to the profit and loss account as an outgoing and such provision is to be allowed as a permissible deduction in computing the profit on the basis of which the value of the shares is to be made according to the profit-earning capacity.

The learned counsel for the revenue, however, defended the Tribunal''s order holding that the reserve for bad and doubtful debts is not a revenue deduction, and cannot be allowed to reduce the maintainable profit. He submitted that the relevant portion of para 4 in the circular is para 4(iii) : "Adjustments will be made for expenditure which is not of a revenue nature and is debited in the accounts and for receipts which are revenue receipts and are not accounted for in the profit and loss account". The circular is contained in 135 ITR (St.) 11-13.

For this purpose, he also referred to the provisions of section 36(1)(vii) and section 36(2)(i) of the income tax Act, 1961 (''the Act") to show that it is only the bad debt actually written off or eligible for being written off in terms of the said provisions which can be permitted to be an outgoing from the profit while determining the maintainable profit. But the reserve for bad debt does not satisfy any of the conditions necessary for allowance of deduction of any debt as bad debt.

We have perused the circular of the Board. The features that the circular presents are:

(i) The working of maintainable profit is to start with the book profits of the company.

(ii) The adjustments to be made in terms of the said circular are exhaustive. The para uses the expression ''following adjustments''. The word ''following'' is significant. It clearly spells out that anything not mentioned in the said enumeration cannot be a subject-matter of adjustment by way of exclusion or inclusion.

From this, it is quite-obvious that maintainable profits should represent commercial profits.

It is submitted on behalf of the assessee that the method of computation of the profit-earning capacity of a company as prescribed by the said circular begins with the book profit of the company for five years immediately preceding the valuation date. Therefore, the book profit is the base of such computation. The book profit shall, however, be adjusted to some extent as indicated in the circular. The adjustments prescribed are in respect of nonrecurring and extraordinary items of income and expenditure as well as loss. Therefore, where there is no uncommon feature in the components of book profits of each year of the block of five years, book profits as such are to be the profits to be capitalised. That besides, the special debits by way of development rebate or investment allowance should be added back. Again, the appropriate tax liability of the company on the book profits so determined will be deducted and the prior liability upon profit required for dividends on shares with prior rights, i.e., preference shares, excluded. It is the average of such adjusted book profits during the said period of five years which shall be the maintainable profits. So, the very basis of the circular shows that whatever is the profit determinable, according to the accepted principles of accountancy, shall be the basis of valuation. Therefore, that profit will be a different quantum from total income computable under the income tax Act. According to the commercial principles of determining profit, provision for doubtful debts is a necessary incident. Because commercial prudence requires it that some loss for debts which are doubtful should be provided for and such provision is made on a basis not altogether arbitrary and unreal.

In this connection, the learned counsel appearing for the assessee, drew our attention to the fact that the Supreme Court in Metal Box Company of India Ltd. Vs. Their Workmen, at page 67 observed that the estimated gratuity liability ascertained on actuarial basis is deductible from the gross receipts while preparing the profit and loss account. Thus, it is merely a matter of logical extension and a corollary of that principle that a reasonable provision for doubtful debts should be deducted while computing commercial profits. It has been further submitted that the Supreme Court in Standard Mills Co. Ltd. Vs. Commissioner of Wealth-tax, Bombay City, pointed out that though the estimated liability of gratuity would not be a debt for the purpose of section 2(m) of the Act, it would, however, be deductible under the income tax Act while computing the taxable profit. These observations highlight the fact that to a limited extent even if contingent character attaches to a liability, it may be a legitimate deduction from profit. Therefore, the deductibility of the provision forbad and doubtful debts has a greater eligibility for deduction, though not from the taxable profit, yet from the commercial profit.

The learned counsel for the revenue expressed apprehensions that the circular lends itself to the risk of being construed against the statutory provision and that the circular has binding effect so long as its effect is contained within the limits of the statutory provision. For this purpose he cited the decisions in Hindustan Aeronautics Ltd. Vs. Commissioner of Income Tax, Karnataka-I, and Bharatiya Engg. Corpn. (P.) Ltd. v. R.G. Deshpande, Addl CIT [1981] 130 ITR 442 (Bom.). He tried to show that the provision for bad and doubtful debts cannot be equated as debts which have become bad and irrecoverable. According to him, it is only the bad debt which could be an allowable debit against the profit. To lay stress on his contentions he took us through the provisions of some relevant portion of rule 2C of the Wealth-tax Rules, 1957 (''the Rules''), specially the portion dealing with adjustments in the value of an asset not disclosed in the balance sheet.

The value of an asset not disclosed in the balance sheet shall be taken to be:

(a) in the case of a debt due to the assessee, the amount due to the assessee under that debt, and where such amount or part thereof has been allowed as a deduction under clause (vii) of sub-section (1) of section 36 of the income tax Act, 1961, in computing the total income of the assessee for the relevant year for the purposes of assessment under that Act, the amount of the debt as reduced by the deduction to be allowed;

(b) in the case of goodwill purchased by the assessee for a price, its market value or the price actually paid by him, whichever is less;

(c) in the case of managing agency rights purchased by the assessee for a price, its market value or the price actually paid by him, whichever is less;

(d) in the case of any other asset, its market value on the valuation date.

The assessee''s counsel relied upon the decision of Saran Engg. Co. Ltd. ''s case (supra). In that case it has been held that in computing capital for the purpose of standard deduction under the Super Profits Tax Act, 1963 bad and doubtful debts should be treated as reserve. That was a case under the Super Profits Tax Act and in that case at page 746 of the Reports the Supreme Court has stated that so far as bad and doubtful debts are concerned, in the light of the facts found, this may be treated as reserve. But in the instant case, we are to construe the provisions of the Act and the rules framed thereunder in juxtaposition to the provisions for allowance of bad debts as contained in section 36(1)(vii) of the 1961 Act. Provisions for bad and doubtful debts are not admissible as deductions in computation of taxable profit. If it is not admissible as deduction u/s 36(1)(vii), it cannot as well be taken into account in calculating maintainable profit. The amount relating to provision for bad and doubtful debts represents contingent liability.

With regard to the provision for gratuity it is submitted that the provision for gratuity is not allowable under provisions of section 40A(7) of the 1961 Act, relating to the assessment years after 1973-74 onwards. In paragraph 6 of its order, the Tribunal observed:

It is further mentioned by the approved valuer in his report that no provision for gratuity and pension has been made in the accounts of the company for the years ending on 31st March, 1975, 31st March, 1976, 31st March, 1977, 31st March, 1978 and 31st March, 1979.

So, the learned counsel for the revenue urged that the provision for gratuity cannot be deducted in calculating the maintainable profit of Karam Chand Thaper & Bros. (P.) Ltd.

Reference has been made in support of this contention to the decision of the Supreme Court In the case of Shree Sajjan Mills Ltd. v. CIT [1985] 156 ITR 585 1. It has been held therein that from the assessment year 1973-74,the allowability of gratuity depends upon fulfilment of the conditions laid down in section 40A(7), whether or not any provision has been made therefor. In taking that view, the decisions of this Court in Peoples Engg. & Motor Works Ltd. v. CIT [1981] 130 ITR 174 2 and Commissioner of Income Tax Vs. New Swadeshi Mills of Ahmedabad Ltd., have been approved. Support has also been sought in the decision of the Supreme Court in Standard Mills Co. Ltd. ''s case (supra) and the decision of the Kerala High Court in Commissioner of Wealth-tax Vs. K. Gopinathan Nair, , and the decision of the Bombay High Court in the case of Century Spg. and Mfg. Co. Ltd. Vs. Commissioner of Wealth-Tax, All these decisions indicate that in ascertaining the value of assets u/s 7 of the Act, estimated liability in respect of gratuity and pension for the benefit of the employees in respect of period of service up to the valuation date is not deductible. It follows, therefore, that these liabilities are not to betaken into account in calculating maintainable profit of Karam Chand Thapar & Bros. (P.) Ltd.

Liability for payment of pension arises on the retirement of a person. In this case, there is nothing to hold that the employees got the right to get pension on retirement or on the fulfilment of conditions made in the pension scheme.

Thus, the provision for gratuity and provision for pension made by the company even if made on actuarial basis after the assessment year1973-74 could be treated as contingent liability within the meaning of Explanation II(ii)(f) to rule ID of the Rules.

We agree with the learned counsel for the revenue that there is nothing to hold that the circular specifically allows provision for gratuity and pension. The expenditure is not of a revenue nature after the Introduction of the provisions of section 40A(7) in view of the principle laid down by the Supreme Court in Shree Sajjan Mills'' case (supra).

The decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra) is not applicable for the interpretation of section 7, read with rule ID. That case deals with super profits tax. The Supreme Court at page570 of the Report held 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 determined having regard to the true nature and character of the sum so retained or appropriated depending upon 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 is to be regarded.

Therefore, in our view, the provisions for gratuity and pension are not deductible in computing maintainable profit. Thus, the thrust of the contentions made on behalf of the revenue was that in computing commercial profit for the purpose of determining the yield value of the equity shares of investment companies, the deduction from the profits on account of debts is allowable only to the extent the debts have become bad. There is no scope for a deduction on the basis of provision for bad and doubtful debts. To construe that the commercial profit for the purpose of computing the value of unquoted shares by yield method should be commercial profit is not consistent with the provisions and, therefore, the circular of the department heavily relied upon by the learned counsel for the assessee is not to be followed.

The circular of the Board being No. 332A of 31-3-1982 relied upon by Dr. Pal, in fact, is not of much assistance. It cannot be said from the reading of the circular that it has relaxed computation of maintainable profits or in terms allows as revenue deduction the provision for doubtful debts. The circular merely says that adjustments will be made to the book profits in respect of non-recurring and extraordinary items of income and expenditure and losses. It further says that adjustments will be made for expenditure which though not of a revenue nature is debited in accounts and for receipts which are revenue receipts and are not accounted for in the profit and loss account. It further permits allowance of appropriate tax liability as deduction from the book profits. It also admits of deduction of the dividend on preference shares from the profit. Paragraph 4 of the circular dealing with the computation of maintainable profits for the purpose of yield method ''valuation'' is extracted below:

For the purpose of para 3(ii) above, the following adjustments may be made for working out the maintainable profits:

(i) The book profits of the company for the five years immediately preceding the valuation date will be ascertained.

(ii) Adjustments will be made to the book profits for each of the said five years for all non-recurring and extraordinary items of income and expenditure and losses.

(iii) Adjustments will be made for expenditure which is not of a revenue nature and is debited in the accounts and for receipts which are revenue receipts and are not accounted for in the profit and loss account.

(iv) The development rebate/investment allowance, in case, it is debited in the books of account, will be added back.

(v) The appropriate tax liability of the company on the book profits so determined will be deducted.

(vi) The profits required for paying dividends on shares with prior rights, i.e., preference shares, shall be excluded.

(vii) The average of the company''s book profits, as adjusted above, will be determined.

The rate of capitalisation may be taken at 10 per cent of the maintainable profits of the company in the case of investment companies other than those which derive the major part of their income from house property and 8.5 per cent in the case of investment companies which derive the major part of their income from house property.

It would be clear from the reading of the circular that the circular directly does not provide any answer whether the provision for doubtful debts should be deducted. Thus far it is, however, clear that the maintainable profits for the purpose of valuation are not the taxable profits. Here the word ''profits'' follows a different concept.

The most important part of the submission made on behalf of the revenue is the contention that rule 2C providing for the adjustments to be made in the book value of an asset provides a clue. Clause (a) of the said rule, as we have earlier observed, permits deduction from the debt as the asset of such amount or part thereof as has been allowed as a deduction under clause (vii) of sub-section (1) of section 36 of the income tax Act in the computation of total income. Thus, it gives a clear pointer that the rules do not conceive of allowance of reserve or provision for doubtful debts because doubtful debts are not deductible u/s 36(1)(vii). It is only bad debt actually written off which is deductible in determining the maintainable profit. That being so, even for determination of the maintainable profit per yield method the deduction allowable is only in respect of bad debt that could be a revenue deduction but not any part of the profit set apart against doubtful debts. It is not that the Act and rules framed thereunder giving computation of commercial profit give a free rein. Broadly, maintainable profit is the commercial profit subject, however, to such adjustments as the rule-making authority may prescribe. Therefore, there is nothing explicit in the circular to show that it has whittled down the requirement of rule 2C. Therefore, the submission of the learned counsel for the revenue on this aspect has force and we are not persuaded to subscribe to the view advanced by Dr. Pal in this respect.

We answer the first question in the affirmative and against the assessee and in favour of the revenue. There will be no order as to costs.

Sen, J.

I agree.