Commissioner of Income Tax vs Tamil Nadu Industrial Investment Corporation Ltd. Tamil Nadu Industrial Investment Corporation Ltd. Vs Commissioner of Income Tax

N.V. Balasubramanian, J.—This is a combined reference both at the instance of the Department and at the instance of the assessee.

In so far as the question of law referred at the instance of the Department is concerned, the question reads as under :

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the interest, guarantee commission and

commitment charges kept in suspense account cannot be treated as the assessee''s income liable to tax ?

There is no dispute that the question raised at the instance of the Department is concluded in favour of the Department by recent decisions of the

court in COMMISSIONER OF Income Tax Vs. TAMIL NADU INDUSTRIAL INVESTMENT CORPORATION LTD. (NO. 1)., and

COMMISSIONER OF Income Tax Vs. TAMIL NADU INDUSTRIAL INVESTMENT CORPORATION LTD. (NO. 2)., wherein this court

held that the interest, guarantee commission and commitment charges kept in suspense account should be treated as the assessee''s income and the

asses-see is liable to tax. We fully agree with the reasoning contained in both the decisions and following the earlier two decisions of this court, our

answer to the question of law referred at the instance of the Department is in the negative and in favour of the Department.

Regarding the assessee''s reference, the question of law referred at the instance of the assessee reads as under :

Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in holding that the reserve created for earlier years

was not available to make good the deficiency in subsequent year wkhin the meaning of Section 36(1)(viii) and, therefore, the claim should be

allowed only to the extent of Rs. 17,75,000 as against the claim of Rs. 19,49,820 ?

The assessee, a financial institution and a Government company, is engaged in providing long term finance for industrial concerns. During the

previous year relevant to the assessment year 1975-76, the assessee created a special reserve of Rs. 19,49,820 and sought its deduction. The

Income Tax Officer found that the actual reserve created during the year under consideration in the books was Rs. 17,75,000 and the assessee

was entitled to claim deduction only to that extent and not on the balance amount carried forward from the earlier assessment years.

The Commissioner of Income Tax (Appeals), however, on appeal, took a different view and held that the overall reserve maintained by the

assessee should be taken into account and that the assessee was entitled to the deduction of the entire sum of Rs. 19,49,820.

On an appeal by the Department, the Tribunal took the view that in view of the provisions of Section 36(1)(viii) of the Act, the assessee was

entitled to claim deduction of only of Rs. 17,75,000 created as a special reserve during the assessment year under reference and the balance of the

amount from the total sum of Rs. 19,49,820 represented the surplus reserve created by the assessee during the earlier assessment years, viz.,

1973-74 and 1974-75, and on such surplus reserve carried forward by the assessee from the earlier assessment years, the claim of the assessee is

not permissible under the law. It is against this order, the assessee has come forward with this reference.

The question referred at the instance of the assessee relates to an interpretation of Section 36(1)(viii) of the Act. u/s 36(1)(viii) of the Act,

subject to certain conditions a deduction is provided in respect of any special reserve created by a financial corporation of an amount not

exceeding 40 per cent. or in the case of other financial corporations 25 per cent. or 10 per cent. of the total income (computed before making any

deduction under Chapter VI-A), as the case may be, carried to such reserve account. The deduction contemplated u/s 36(1)(viii) is with reference

to the special reserve created from the total income carried to such reserve account. If the assessee had some surplus reserve in the earlier year

and it was carried forward, then, with regard to the claim of deduction, in our opinion, it is not a reserve created from the total income carried to

such reserve account. The crucial words are ""40 per cent. of the total income"" and ""carried to such reserve account"". We are of the opinion that

the special reserve must be created out of the total income of the relevant previous year and the presence of a larger reserve in the earlier year

cannot be taken to mean that a special reserve was created out of the total income of the relevant previous year. The section uses the words,

special . reserve created"", and the amount must also be carried to such reserve account. That apart, the special reserve must be created by the

financial corporation out of the total income computed before making any deduction under Chapter VI-A of the Act. The words ""computed before

making any deduction"" also establish that the reserve must be created out of the total income of the concerned year. Therefore, it is imperative to

claim deduction that the creation of the reserve should be out of the total income of the relevant previous year from which deduction is claimed,

and not from the total income of the earlier year. If it is held otherwise, the statutory percentage of the reserve created from the total income and

carried to the reserve will have no meaning. If the assessee points out to earlier years surplus and says that the reserve was created, such a reserve

cannot refer to a reserve created out of the total income of the relevant previous year. The section contemplates the creation of the reserve in each

year and carried to the special reserve in each year, and such reserve created would become final and complete, and it is not possible for the

assessee to draw from the reserve of previous years and then to point out that the assessee had created reserve to the extent of 40 per cent. of the

total income.

The legislative history makes the position clear, when Clause (viii) of Section 36(1) of the Act was introduced a deduction was granted for an

amount not exceeding 10 per cent. of the total income carried to such special reserve. When it was amended by the Finance Act, 1966, the limit

was raised to 25 per cent. in the case of financial corporations whose paid up share capital did not exceed three crores of rupees. By the Finance

Act, 1974, and in the case of financial corporations of the type with which we are concerned, where the paid up share capital did not exceed three

crores of rupees, it was limited to 25 per cent. and where the paid up share capital did exceed three crores of rupees, it was limited to 10 per cent.

of the total income. The legislative history shows that the Legislature intended that the financial institutions should build up a reserve out of the

current profits and with a view to create a higher reserve, the percentage of deduction was gradually increased.

That apart, the Legislature has inserted an Explanation with effect from April 1, 1966, which provided for making good the deficiency of one

year in the creation of reserve out of the excess of the earlier year and the Explanation reads as under :

Explanation--For the removal of doubts, it is hereby declared that in the case of a financial corporation to which Sub-clause (a) applies, if the

amount carried to the reserve account referred to in this clause in the accounts of the previous year relevant to the assessment year commencing on

the 1st day of April, 1966, falls short of twenty-five per cent. of the total income and the amount transferred to such reserve account in the

accounts of the immediately succeeding previous year exceeds the amount in respect of which the corporation is entitled to the deduction under this

clause for the assessment year commencing on the 1st day of April, 1967, an amount equal to such excess shall, for the purpose of allowing the

deduction under this clause, be deemed to have been transferred to the reserve account in the accounts of the first-mentioned previous year.

But, this Explanation was omitted by the Finance Act, 1974, with effect from April 1, 1975. The omission was made with a view to facilitate

the building up of internal resources of financial corporations or joint financial corporations and at the same time it was proposed to increase the

rate of deductible amount in the case of financial corporations or joint financial corporations to 40 per cent. of the current profits. On the

introduction of the Finance Act, 1974, financial corporations providing long-term finance to industrial and agricultural development in India were

entitled to a deduction of the amount transferred by them out of the current profits to the special reserve account at 55 per cent. of the taxable

income. It is with that object in view that the Explanation was omitted by the Finance Act, 1974, with effect from April 1, 1975, and if we accept

the contention urged on behalf of the assessee that it is open to the assessee to rely upon the surplus reserve of earlier years, it will defeat the

object behind the legislative intention in deleting the Explanation to Section 36(1)(viii) of the Act. The omission of the Explanation makes it clear

that the excess reserve of an earlier year is no more available in making good the deficiency in the succeeding year, and it is impermissible for the

assessee to resurrect the Explanation.

In Commissioner of Income Tax Vs. Aruna Sugars Ltd., this court has taken a view that under the Explanation to Section 34(3) of the Act, the

deduction of development rebate should not be denied by reason only that the amount debited to the profit and loss account of the relevant

previous year and credited to the reserve account exceeded the amount of such profit of the previous year as arrived at without making the debit

account. This court further held that the Explanation makes it clear that the creation of a reserve of requisite amount must come out of the profit of

the relevant previous year. It was emphasised by this court that the creation of a reserve must be out of the profit of the relevant previous year and

unless there is a debit in the profit and loss account, the assessee was not entitled to development rebate. The same view was reiterated by this

court in the case of Commissioner of Income Tax, Madras Vs. Arasan and Company, .

Unless the assessee creates a special reserve out of the income of the previous year, the assessee is not entitled to claim the deduction u/s

36(1)(viii) of the Act. The statutory condition is that the reserve must be out of the profit of the relevant previous year. The decision relied upon by

learned counsel for the assessee in Ravi Kumar Mehra Vs. Commissioner of Income Tax, wherein the Punjab and Haryana High Court dealt with

a case of deduction u/s 80C of the Act and the court held that the amount of the Life Insurance Corporation premium need not come out of the

income chargeable to tax is not of any assistance to the assessee. We are not expressing any opinion on the correctness of the view expressed by

the Punjab and Haryana High Court except to point out that u/s 36(1)(viii) of the Act, the special reserve should not only be created out of the

income chargeable to tax, but must be carried to reserve account. Hence, the decision of the Punjab and Haryana High Court in Ravi Kumar

Mehra Vs. Commissioner of Income Tax, , has no application to the facts of the case.

The object of granting deduction u/s 36(1)(viii) is to strengthen the financial resources of the financial corporation or the joint financial

corporation and the deduction is granted out of the total income before making any deduction under Chapter VIA of the Act. The section provides

for a higher deduction and the section also enjoins that the amount must be carried to a special reserve account and once a special reserve was

created and the amount was carried to the special reserve account, it is not open to the assessee to draw from such special reserve and make up

the deficiency in the succeeding assessment years. If such a contention of the assessee is accepted the whole purpose behind the creation of the

reserve in strengthening the financial position would be defeated. The Tribunal, in our opinion, has come to the correct conclusion in holding"" the

claim of the assessee must be with reference to the reserve created for each year and the excess reserve of an earlier year is not available for

making good the deficiency in a succeeding year. There is no error in the view taken by the Appellate Tribunal.

Accordingly, we answer the question of law referred at the instance of the assessee in the affirmative and against the assessee. The assessee is

directed to pay costs of Rs. 750 to the Revenue.