Commissioner of Income Tax vs Hemalatha Textiles Ltd.

S. Ratnavel Pandian, Offg. C. J.

In this reference which arises under the provisions of the Companies (Profits) Surtax Act, 1964, the following question of law has been referred

to this court u/s 18 of the Companies (Profits) Surtax Act, 1964, read with section 256(1) of the Income Tax Act, 1961:

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the amount standing to the ''plant

replacement reserve'' should be taken as capital for levy of surtax?

The assessee has been assessed to surtax for the assessment year 1975- 76. The assessee took up the stand that the ""plant replacement

reserve"" should be treated as a free reserve for there purpose of inclusion in the capital computed under the Second Schedule to the Act. While

completing the surtax assessment for the said assessment year, the Income Tax Officer held that the amount standing to the ""plant replacement

reserve"" is not a reserve and should not be taken as a capital for the purpose of levy of surtax, as it is provided to meet a specific liability. On

appeal, the Commissioner of Income Tax (Appeals), following the decision of the Appellate Tribunal in the case of Gordon Woodroffe and Co.

Ltd. (I. T. A. Nos. 14 and 15 (Mds)/1981- 82 dated January 29, 1982,) for the assessment years 1976-77 and 1977- 78, held that the plant

replacement reserve should be taken as capital for levy of surtax. In the appeal filed by the Department, this finding has been confirmed by the

Appellate Tribunal. It is against this order of the Tribunal that the Revenue sought for and obtained an order of reference of the question of law

referred to supra for an authoritative pronouncement on the question referred.

The point for consideration is whether the amount set apart towards ""plant replacement reserve"" should be classified as a reserve or as a

provision. As already stated, the assessee took up the stand that it should be treated as a free reserve for the purpose of inclusion in the capital

computed under the Second Schedule to the Act. The Income Tax Officer held that it represented a provision for a specific purpose and hence

cannot be regarded as a reserve. The Commissioner of Income Tax (Appeals), however, noticed that the reserve was created in the profit and loss

appropriation account and not in the profit and loss account. The appellate authority further found that the entire reserve of Rs. 2,80,000 was

transferred to a general reserve account in the year ending on June 30, 1975. The Tribunal, on further appeal by the Department, relying on its own

order in the case of Gordon Woodroffe and Co. Ltd. (I. T. A. Nos. 14 and 15 (Mad) 1981-82 dated January 29, 1982), held that the plant

replacement reserve could not be treated as a provision.

A Division Bench of this court (Ramanujam and N. A.Sathar Sayeed JJ.) in T. C. Nos. 1001 and 1002 of 1982 judgment dated February 11,

1985 (CIT v. Gordon Woodroffe and Co., Madras) following the decision in T. C. Nos. 320, 321 and 375 of 1978 dated September 19, 1983

Commissioner of Income Tax Vs. Gordon Woodroffe and Co. (Madras) Private Ltd., held that the plant replacement reserve could not be treated

as a reserve since it was created for a particular purpose and accordingly answered the question in favour of the Revenue. Normally, we would

have followed these decisions and rendered an answer to the question referred to this court. But subsequently, the Supreme Court, while

considering a similar issue in Commissioner of Income Tax, Kanpur Vs. Elgin Mills Ltd., Kanpur, and in Commissioner of Income Tax, Kanpur

Vs. Saran Engineering Co. Ltd, , held that while ""provision"" is a charge on profits which are taken into account in the gross receipts of the profit

and loss account, ""reserve"" is an appropriation of profits to provide for the asset which it represented. In Commissioner of Income Tax, Kanpur

Vs. Elgin Mills Ltd., Kanpur, , the Supreme Court has applied the principle enunciated in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others

Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, .

In Commissioner of Income Tax, Kanpur Vs. Saran Engineering Co. Ltd, , while dealing with the ""fleet replacement reserve"", the Supreme

Court confirmed the finding of the Tribunal and the High Court that this reserve was like the reserve for contingencies, and here also there was no

liability in praesenti towards purchase of any vessel on the first day of the accounting year and this sum also was includible in the capital base. The

Supreme Court observed that in view of the facts as recorded by the Tribunal and in the light of the principles settled by various decisions and

reiterated by the Supreme Court in Commissioner of Income Tax, Kanpur Vs. Elgin Mills Ltd., Kanpur, , it is not necessary to call for any

statement of the case and the High court was right. The Supreme Court observed as follows (at page 748):

It may be mentioned that where the liability has actually arisen or is anticipate legitimately by the assessee though the quantum of the liability has

not been determined, a fund to meet such present liability cannot be treated as ''reserves''. A fund, however, created for payment of a liability

which had not already arisen or fallen are but is only a provision with regard to the sum that might become liable to be paid is ''other reserves''

within the meaning of rule 1 of the Second Schedule and should be taken into account in computing the capital of the company for the purpose of

the Companies (Profits) Surtax Act, 1964.

In Commissioner of Income Tax, Kanpur Vs. Elgin Mills Ltd., Kanpur, , the Supreme Court has observed as follows (headnote):

The distinction between ''provision'' and ''reserve'' is that while ''provision'' is a charge on profits which are taken into account in the gross receipts

of the profit and loss account, ''reserve'' is an appropriation of profit to provide for the asset which it represented.

Thus, the Supreme Court has laid down that only when the amount set apart is towards a specific liability in respect of plant replacement, it

could be regarded as a provision and when the amount set apart is for future contingency that might arise for replacement of plant, then it could be

classified only as a reserve. In this context, the finding of the Commissioner of Income Tax (Appeals) in this case will be relevant as he had found

that the reserve was created in the profit and loss appropriation account and subsequently it was transferred to a general reserve. This finding only

shows that this amount was not earmarked for purchase of any specific machinery in respect of which a liability has already acquired. This is only

created for a contingency and hence it could not be classified as a provision.

We are of the view that the decisions of the Supreme Court referred to above would clearly apply to this case. In the circumstances, we are

unable to follow with respect, the two decisions of this court in the case of Gordon Woodroffe (Mad) P. Ltd. which area reported. Following the

decision of the Supreme Court in Commissioner of Income Tax, Kanpur Vs. Saran Engineering Co. Ltd, , we answer the question of law referred

to this court in the affirmatives and against the Department. No costs.