Commissioner of Income Tax vs National Rayon Corporation Ltd.

T.D. Sugla, J.—In this departmental reference relating to the assessee''s assessment for the assessment year 1973-74, the Income Tax Appellate Tribunal has referred to this court the following three questions of law for opinion u/s 256(1) of the Income Tax Act, 1961 :

"1. Whether, on the facts and in the circumstances of the case, the dividend of Rs. 1,37,66,585 declared on May 3, 1972, should go to reduce the general reserve of Rs. 4,01,10,167 as at January 1, 1972, for the purpose of computing the capital in terms of rule 1 of the Second Schedule to Companies (Profits) Surtax Act, 1964, for the assessment year 1973-74 ?

Whether, on the facts and in the circumstances of the case, the debenture redemption reserve of Rs. 1,41,00,000 constitutes a reserve includible in the computation of capital in terms of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, for the assessment year 1973-74 ?

Whether, on the facts and in the circumstances of the case, the gratuity reserve of Rs. 17,00,000 constitutes a reserve includible in the computation of capital in terms of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, for the assessment year 1973-74 ?"

Counsel are agreed that, in view of the Supreme Court judgment in the case of Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, , the first question will have to be answered in the affirmative and in favour of the Revenue. The question is so answered.

As regards questions Nos. 2 and 3, it is the submission of Dr. Balasubramanian, learned counsel for the Revenue, that both these questions are covered by our court''s judgment in the assessee''s own case in Commissioner of Income Tax Vs. National Rayon Corporation Ltd., in favour of the Revenue, Shri Mehta, learned counsel for the assessee, on the other hand, stated that, after our court''s judgment, the Supreme Court observed in Commissioner of Income Tax, U.P. Vs. Laxmi Sugar and Oil Mills Ltd., , Commissioner of Income Tax, Kanpur Vs. Elgin Mills Ltd., Kanpur, and Commissioner of Income Tax, Kanpur Vs. Saran Engineering Co. Ltd, , that "it is now settled that a ''provision'' is a charge against the profits being made against anticipated losses and contingencies. A ''reserve'', on the contrary, is an appropriation of profits, the assets by which it is represented being retained to form part of the capital employed in the business." The submission is that unlike a "provision" which is a charge against the profits, the assessee continues to enjoy a proprietary interest in the "reserve" Inviting then our attention to the fact that both debenture redemption reserve and gratuity reserve in this case were not claimed as a charge against the profits, he contended that these two reserves ought to be treated as reserves rather than provisions. Shri Mehta also invited our attention to the Calcutta High Court decisions in the case of Commissioner of Income Tax Vs. Placid Limited, and the Karnataka High Court decision in the case of Addl. Commissioner of Income Tax, Mysore Vs. Bharat Fritz Werner (P) Ltd., , where redemption reserve in respect of preference shares was held to be a "reserve".

We have gone through the above three decisions of the Supreme Court as well as the Calcutta and Karnataka High Courts'' decisions relied on by Shri Mehta carefully. No doubt, there is an observation in the Supreme Court decisions that a provision is a charge against profits. It is, however, seen that in Commissioner of Income Tax, U.P. Vs. Laxmi Sugar and Oil Mills Ltd., , the Supreme Court referred to its still earlier decision in the Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, . In that case, the Supreme Court had referred to its still earlier decision in the case of Metal Box Company of India Ltd. Vs. Their Workmen, , wherein a reference was made to a quotation from Spicer and Pegler''s Book-keeping and Accounts. The headnote of the case is, thus, to that extent, not very correct. Moreover, in those very decision, the question of forfeited dividend reserve had come up for consideration and it was held that such a reserve was not to be treated as a reserve. It is needless to mention that dividends are never a charge against profits. They are distributed out of the profits after the profits are computed. In its decision in Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, , also the Supreme Court examined the meaning of "reserve", inter alia, in the context of dividend. In the circumstances, it is not possible to accept that our court''s judgment in the assessee''s own case in Commissioner of Income Tax Vs. National Rayon Corporation Ltd., has been even impliedly overruled by the Supreme Court. As regards the Karnataka and Calcutta High Court decision, we find that in both the cases the reserve was for the redemption preference shares. Whether preference shares should or should not be redeemed is a right vested in the company and not in the shareholders whereas in the case of debentures, the right to get debentures redeemed vest in the debenture-holders. The two cases are, therefore, not applicable in the facts of this case.

Accordingly, following our judgment in the assessee''s own case in Commissioner of Income Tax Vs. National Rayon Corporation Ltd., , we would hold that the debenture redemption reserve is not a reserve and answer the second question in the negative and in favour of the Revenue. We will also answer the third question in the negative and in favour of the Revenue subject only to this that when the matter goes back to the Tribunal for passing an order in accordance with the judgment of this court, the Tribunal will consider whether the gratuity reserve of Rs. 17 lakhs is in excess of the assessee''s actual gratuity liability on actuarial basis and the excess, if any, will be treated as reserve.

No order as to costs.