Commissioner of Income Tax vs K.C.P. Ltd.

Anjaneyulu, J.—In this reference u/s 18 of the Companies (Profits) Surtax Act, 1964 (''the Surtax Act'') read with section 256(1) of the income tax Act, 1961 (''the Act''), the Tribunal referred for the opinion of this Court two questions-one at the instance of the Commissioner and another at the instance of the assessee. The two questions are extracted:

Question at the instance of the Commissioner :

"Whether, on the facts and in the circumstances of the case, rule 4 of the Second Schedule to Companies (Profits) Surtax Act, 1964, is applicable to deduction u/s 80 or to income exempt u/s 10 of the Act only for computing the capital and ascertaining the standard deduction?"

Question at the instance of the assessee :

"Whether, on the facts and in the circumstances of the case, the development rebate reserve transferred to the general reserve at the end of the statutory period is to be excluded from ''other reserves'' under rule 1 (iii) of the Second Schedule of the Companies (Profits) Surtax Act for the purpose of computation of capital base?

The counsels for both sides represented that the answer to the first question is covered by a decision of this Court in Commissioner of Income Tax, Andhra Pradesh Vs. Indian Detonators Ltd., in favour of the assessee. We, accordingly, answer the question referred to us at the instance of the Commissioner in favour of the assessee and against the revenue upholding the view taken by the Tribunal.

As regards Question No. 2, referred to us at the instance of the assessee, it may be relevant to notice a few facts. The assessee- company claimed deduction in its income tax assessment in respect of development rebate u/s 33 of the Act and for that purpose created the required reserve. After the expiry of the statutory period of eight years, the assessee-company had written back the reserves. In its surtax assessment, the assessee claimed that the capital employed in the business under Schedule II of the Surtax Act should be computed taking, inter alia, into account of the entire balance standing to the credit of the general reserve account on the opening day of the accounting year relevant for the assessment years 1972-73, 1973-74 and 1974-75. The ITO was of the view that the general reserve account included sums of Rs. 23,37,630, Rs. 50,87,630 and Rs. 55,87,630 which was the aggregate of the development rebate reserve transferred by the assessee to the general reserve account. The ITO held that the development rebate reserve forming part of the general reserve account was allowed as a deduction in computing the total income of the assessee for the relevant assessment years and consequently, it fell to be excluded by reason of rule 1(iii) of the Second Schedule to the Surtax Act. In this view the ITO excluded the above-mentioned sums while computing the capital for the purpose of the Surtax Act. The assessee appealed to the AAC who allowed the appeal on the short ground that the development rebate reserve forming part of the general reserve was not allowed as a deduction in computing the total income. According to the AAC, what was allowed in the computation of total income was development rebate u/s 33 and the development rebate reserve is entirely distinct from the statutory allowance given to the assessee by way of development rebate. The AAC, therefore, held that the ITO was in error in excluding the aforementioned sums. Aggrieved by the orders of the AAC, the ITO filed appeals for all the three assessment years before the Tribunal. The Tribunal reversed the orders of the AAC and upheld the department''s contention that to the extent the development rebate reserve formed part of the general reserve, it was liable to be excluded in the computation of income. In that view, the Tribunal set aside the order of the AAC on this point and restored the ITO''s order. The assessee thereupon required the Tribunal to refer the aforesaid question to this Court u/s 256(1).

The learned counsel for the assessee, Shri S. Parvatha Rao, complains that the authorities below including the Tribunal proceeded to determine the question relating to the exclusion of development rebate reserve on a mistaken view of facts. The learned counsel pointed out that the assessee''s contention throughout has been that after the expiry of the statutory period of eight years, the development rebate reserve had been written back to the profit and loss account and, consequently, it formed part of the profit, which was the subject-matter of various allocations for each of the three accounting years relevant for the assessment years 1972-73, 1973-74 and 1974-75. The contention in this form was urged before the ITO as is evident from the assessment orders. It is stated that the attention of the Tribunal had also been drawn to this aspect and the Tribunal had, in paragraph 5 of its order, extracted the relevant portion of the assessment order of the ITO which contained the above contention. Shri Parvatha Rao urges that notwithstanding the above contention, the Tribunal proceeded on the mistaken view that the development rebate reserve was transferred by the assessee to the general reserve account straightaway and on that basis reached the conclusion that inasmuch as the development rebate reserve, which formed part of the general reserve, was allowed as a deduction in computing the total income of the assessee, it could not be treated as a reserve for the purpose of computing the capital employed in the business under rule 1(iii) of the Second Schedule to the Surtax Act. The learned counsel placed before us the printed accounts of the assessee-company for the three accounting years under consideration containing the profit and loss account and the balance sheet to support his plea that the development rebate reserve was transferred by the assessee to the profit and loss appropriation account for each of the three years under consideration and not to the general reserve account. It is not disputed that these printed accounts were on the file of the ITO and he had the opportunity to examine them before completing the surtax assessment for all these three years. We, therefore, permitted Shri S. Parvatha Rao to place the printed accounts before us so that we may verify for ourselves the correctness of the contention urged by the assessee. We had scrutinised the profit and loss account and the profit and loss appropriation account for the three accounting years under consideration. We find that the assessee transferred to the profit and loss appropriation account ''development rebate reserve withdrawn as no longer required''. Having done so, the balance in the profit and loss appropriation account was struck and necessary allocations towards reserves were made pursuant to the decision of the directors. It seems to us that the Tribunal did not look into the printed accounts of the assessee for the three years under consideration in order to verify the contention of the assessee that the development rebate reserve for each of the three years was not transferred directly to the general reserve account, but to the profit and loss appropriation account. The assessee has been specifically contending throughout that the transfer was not directly to the general reserve account. Once the development rebate reserve is transferred to the profit and loss appropriation account, it follows that it formed part of the profit available to the assessee for the purpose of making various allocations towards reserves and payment of dividends. For each of the three years, the assessee made different allocations towards reserves including general reserve and the allocations so made, as is apparent from the profit and loss appropriation account for each of the three years, have no reference to the development rebate reserve transferred to the profit and loss appropriation account. We find that in the accounts for the assessment year 1970-71, the assessee made an allocation to the general reserve after transferring development rebate reserve to the extent of Rs. 27,50,000. For the assessment year 1971-72, the assessee transferred to the general reserve account a sum of Rs. 56,00,000 against only Rs. 5,00,000 transferred by way of development rebate to the profit and loss appropriation account. Again for the assessment year 1972-73 while the development rebate reserve transferred to the profit and loss appropriation account was Rs. 9,10,000, the sum transferred to the general reserve account was Rs. 1,42,05,700. It would at once be seen that the allocation made by the assessee towards general reserve for each of the three years has nothing to do with the development rebate reserve transferred to the profit and loss appropriation account. It is, therefore, difficult to subscribe to the view of the Tribunal that the balance to the credit of the general reserve account included the whole or any part of the development rebate reserve transferred by the assessee to the profit and loss appropriation account. It is upon the mistaken view that the assessee transferred the development rebate reserve to the general reserve account that the ITO as well as the Tribunal came to the conclusion that the general reserve account included the balances transferred directly towards development rebate reserve account. In view of the facts which we have set out above, it is clear that no part of the development rebate reserve was included in the general reserve account, and consequently, the Tribunal was in error in holding that in computing the capital under rule 1(iii) and three sums, namely, Rs. 23,37,630, Rs. 50,87,630 and Rs. 55,87,630, respectively, for the surtax assessment years 1972-73, 1973-74 and 1974-75, should be excluded. In our opinion, the above sums are not liable to be excluded.

While scrutinising the profit and loss accounts and the balance sheets placed before us by the assessee, we found that according to the directors'' reports, the following sums were declared as dividends without making necessary appropriations in the profit and loss appropriation account, but by drawing the same either from the dividend reserve or general reserve:

1972-73: Rs. 25,40,933 drawn from the dividend reserve.

1973-74: Rs. 19,05,699.75 drawn from the general reserve.

1974-75: Rs. 38,11,399.50 drawn from the general reserve.

On a perusal of the orders of the ITO for the three years under consideration, we find that the amounts drawn from the general reserve for the assessment years 1973-74 and 1974-75 were not reduced from the balance to the credit of the general reserve account on the opening day of the accounting year relevant for these assessments. The decision of the Supreme Court in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, considered this question and held that any sums drawn from out of the general reserve for purposes of paying dividends should be excluded from the concerned reserve account in order to determine the capital under rule 1(iii). We have pointed out the above error to the learned counsel, Shri S. Parvatha Rao, and suggested to him that appropriate adjustments on the above account should be now made in finally determining the capital. Although this question was not considered directly by the authorities below and Shri Parvatha Rao had some initial reservations on the powers of this Court in considering this question, he fairly conceded at the end that he will have no objection to a direction to the Tribunal to make appropriate adjustments on the above account in finally determining the capital while passing an order conformably to the judgment of this Court. In view of the acceptance of the learned counsel for directing appropriate adjustments, we directed the Tribunal to look into this matter and arrive at the appropriate sum to be reduced from the balance to the credit of the general reserve account following the judgment of the Supreme Court in Vazir Sultan Tobacco Co. Ltd.''s case (supra). It may perhaps be relevant to mention that so far as the assessment year 1972-73 is concerned, no adjustment will be called for on this account because the opening balance of the reserve for this assessment year is not affected by the proposal to draw the same from the dividend reserve account to declare appropriate dividends. The Tribunal will look into this question before determining the matter while passing an order conformably to this judgment.

In the result, we answer the second question referred to us at the instance of the assessee to the effect that the development rebate reserve transferred to the profit and loss account for each of the three assessment years is not liable to be excluded in the computation of capital under rule 1(iii) and at the same time, whatever sums were drawn for the purpose of declaring dividends from out of the reserve accounts affecting the credit balance on the opening day of the accounting years for each of the three assessment years should be reduced in computing the capital under rule 1 (iii). The reference is answered, accordingly. No costs. Advocate''s fee Rs. 500.