Nagammal Mills Ltd. vs Commissioner of Income Tax

Ramanujam, J.—The assessee is a public limited company engaged in the manufacture and sale of cotton yarn. In the year ending on 30th

April, 1961, it made a profit of Rs. 9,91,092. The balance of profit brought forward from the earlier year was Rs. 2,12,352. The board of

directors in their report dated November 12, 1961, to the shareholders recommended the following appropriations for the year.

Rs.

Provision for taxation (after adjustment of the surplus provision of 5,00,000

thepreceding year.)

Proposed dividends :

Preference shares 31,465

Ordinary shares 3,12,020

3,43,485

Provisions for bonus to staff and workers 60,000

Transfer to general revenue 2,00,000

This left a balance of Rs. 99,759 which was carried forward to the next year. In computing the capital base as on May 1, 1961, under Rule 1 to

the 2nd Schedule to the Super Profits Tax Act, the assessee claimed that the following sums should be treated as reserves :

Rs.

Provision for bonus 28,439

Provision for dividend 3,43,485

Provision for taxation 7,50,000

Development rebate reserve 4,598

Item No. 1 represents the balance out of Rs. 60,000 after the, bonus payment of Rs. 31,651 during the year. Item No. 2 represents the amount

set apart towards, dividends and actually paid out as dividends in the year towards preference and ordinary shares. Item No. 3 is made up of the

provision of Rs. 2,50,000 for taxation made prior to May 1, 1961, as also the provision of Rs. ,5 lakhs made on May 1, 1961, as against which a

sum of Rs. 3,8,040 was the actual tax payable by the assessee for the year. Item No. 4 represents the excess development rebate reserve created

by the assessee over and above the 75% fixed under the proviso (b) to Clause (vib) of Section 10(2) of the Indian Income Tax Act, 1922.

The Super Profits Tax Officer disallowed the claim for the inclusion of the above four items in the computation of capital for the reason that they

were merely provisions for specific liabilities and would not constitute reserves, either general or specific, for the purpose of computation of capital

as laid down in Rule 1 of Schedule 2.

The assessee appealed to the Appellate Assistant Commissioner who also upheld the computation of capital made by the Super Profits Tax

Officer. He held that neither the board of directors nor the general body of the shareholders had passed resolutions treating items Nos. 1 to 3 as

reserves. In regard to item No. 4 he held that this was the excess over what had to be created as development rebate reserve and, therefore, it

should not be taken to be a development rebate reserve.

The assessee thereafter appealed to the Appellate Tribunal. It was contended by the assessee that out of Rs. 7,50,000, Rs. 3,87,040 was the

actual tax payable and, therefore, the excess of Rs. 3,62,960 should be considered as a reserve, that the sum of Rs. 4,598 representing the excess

reserve in respect of development rebate and the sum of Rs. 28,439 which is an excess reserve for bonus should all be treated as reserves. It was

also submitted that the amount standing to the credit of the proposed dividend should also be treated as part of the company''s reserve. The

Revenue resisted the assessee''s contention stating that since the assessee was allowed in full the amount of development rebate in the computation

of profits under the Income Tax Act, the excess of Rs. 4,598 cannot be treated as a reserve, that the other items were either specific liabilities or

formed part of the accumulated profits and that, therefore, they cannot be trsated as reserves contemplated by Rule 1 of the Second Schedule.

The Tribunal, relying on the decision of the Supreme Court in Commissioner of Income Tax, Bombay City Vs. The Century Spinning and

Manufacturing Co. Ltd., . held that on the crucial date, that is, on May 1, 1961, the whole of the profits of the company remained unappropriated

to any specific account or specific purpose and no reserve has been created out of the profits by the board of directors or by the general body of

shareholders and, therefore, they cannot be treated as reserves contemplated by Rule 1 of the Second Schedule. It, however, held that, in any

event, the sum of Rs. 2,50,000 already set apart earlier to May 1, 1961, should alone be treated as reserve by the appropriate authorities. As

regards the sum of Rs. 4,598, the excess reserve created towards development rebate, it held that it cannot be treated as a development reserve in

view of the fact that the whole of the amount of the development rebate at the rate of 75% was allowed for the computation of the assessee''s

income.

At the instance of the assessee the following question has been referred to this court in T.C. No. 260 of 1967 :

Whether, on the facts and in the circumstances of the case, the sums provided towards payment of bonus, for payment of dividends and for the

payment of Income Tax totalling in all Rs. 8,71,924 were not reserves under rule No. 1 of the Second Schedule to the Super Profits Tax Act,

1963 ?

At the instance of the revenue the following question has been referred to this court in T.C. No. 261 of 1967.

Whether, on the facts and ia the circumstances of the case, the sum of Rs. 2,50,000 was a reserve under Rule 1 of the Second Schedule to the

Super Profits Tax Act, 1963 ?

The questions thus involve the interpretation of the word "" reserve "" in Rule 1 of Schedule 2 of the Super Profits Tax Act, 1963. We have held

in Commissioner of Income Tax Vs. Indian Steel Rolling Mills Ltd., . that the word ""reserve"" used in the said rule means specific amounts set apart

for specified purposes out of the profits earned in the relevant year by the appropriate authority which is put to future use by the company.

Before considering each of the four items, provision for bonus, dividend, taxation and development rebate reserve, it is necessary to consider

in the first instance the correctners of the reasoning of the Tribunal holding that there is no appropriation made by the competent authority as on

May 1, 1961 ; and, therefore, the sums cannot be treated as reserves. Though the appropriation is made by the company subsequent to the close

of the earlier year, it relates back to the first day of the accounting year, that is, May 1, 1961, in this case, as the words "" as on "" occurring in Rule

1 of Schedule 2 indicate that though the appropriation has been made actually on a later date, it is as on the first day of the previous year (vide

Commissioner of Income Tax, Mysore Vs. Mysore Electrical Industries Ltd., . The position is different in the case reported in Century Spinning

and Manufacturing Co.''s case, which dealt with the provision of Rule 2(1) of Schedule 2 of the Business Profits Tax Act of 1947 which used the

words "" on the first day of the accounting period"" as distinguished from the words "" as on "" used in Rule 1 of Schedule 2 of the Super Profits Tax

Act with which we are concerned. Therefore, the view taken by the Tribunal that the appropriation came to be made subsequent to the first day uf

the previous year and, therefore, it should be taken that on the relevant date the profits have not been appropriated for any particular purpose

cannot, therefore, be accepted. Though the appropriation came to be actually made by the company on November 12, 1961, it should be deemed

to relate back to the first day of the previous year. Therefore, we proceed to consider the questions raised in this case on the basis that there has

been appropriation by the company under the various heads as on May 1, 1961.

The items in dispute relate to the excess provision for bonus, provision for dividend, provision for taxation and the excess development rebate

reserve. So far as the excess provision made for bonus and development rebate reserve is concerned, we arc of the view that the said two items

should be treated as reserve within the meaning of Rule 1 of Schedule 2 to the Act. Though the. said two items represent excess provisions, they

still form part of the allocation for specified purposes and they have been utilised by the company for its business purposes. They are kept in

continuous use in the business ox the company and are treated as part of the capital structure. In this view, these two items have to be treated as

reserves"". The reasoning of the Tribunal as to why the excess development rebate cannot be created as a reserve is that the development rebate

reserve has been allowed as a deduction to the extent of 75% and, therefore, the excess cannot be taken to be a reserve. This cannot be

accepted. The fact that the excess reserve was not allowed as deduction under the Income Tax Act cannot be taken to show that the excess

amount is not a reserve coming within the words "" other reserves "" occurring in Rule 1 of Schedule 2.

Coming to the provision for dividend of Rs. 3,43,485 it is seen that the said dividend has actually been paid out by the company to its

shareholders. Though the same was set apart for a specified purpose, it cannot be said to be available for the future use of the company so as to

partake the character of capital. The said sum set apart for payment towards a specific liability cannot be said to be a reserve for future use of the

company. This sum has, therefore, to be treated as not a reserve.

So far as the provision for taxation is concerned, the total sum set apart was Rs. 7,50,000 as against the actual tax liability of Rs. 3,87,040.

The said sum of Rs. 3,87,040 have been paid out of the company for discharging the actual tax liability, it cannot be taken to be an amount set

apart or appropriated for a specific purpose, or for future use of the company and it is only a provision made for discharging a specific liability.

Therefore, the said sure cannot be treated as a reserve. But the balance of Rs. 3,62,960 representing the excess provision for taxation was

available to the company for its use and, therefore, it has to be treated as a reserve.

The learned counsel for the assesses draws our attention to a decision of the Allahabad High Court in Commissioner of Income Tax Vs.

Security Printers of India (P.) Ltd., ., holding that a provision for bonus, taxation and proposed dividend made by a company is entitled to be

treated as reserves for the purpose of Rule 1 of the Second Schedule to the Act and they should be included in the computation of capital under

that provision if the three items had actually been debited to the assessec''s profit and loss account and had not been allowed as a deduction for the

purpose of Income Tax assessment. But, with respect, we are not able to see how an amount set apart for the discharge of a specific and definite

liability and actually paid out by the company will become a "" reserve "". The learned judges in that case construed the word ""reserve"" as an amount

specifically kept apart for future use or for a specific occasion, and having found that there has been a specific appropriation of the amount under

various heads, they proceeded to hold that the provision for bonus, taxation and for proposed dividends represented amounts specifically set apart

for meeting future liabilities. It does not appear that the revenue contended there that the amounts represented specific liabilities which had arisen

and discharged during the relevant period and were not intended for a future use by the company. The liability to pay Income Tax cannot be said

to be contingent and it has arisen during the previous year, and only the quantification remains to be done after the close of the year. As pointed out

by the Supreme Court in Kesoram Industries and Cotton Mills Ltd. Vs. Commissioner of Wealth Tax, (Central) Calcutta, . the liability to pay

income-ta''x was a present liability though the tax becomes payable after it was quantified in accordance with the ascertainable data, that it

becomes a perfected debt at any rate on the last day cf the accounting year and that it is not a contingent or future liability. The tax liability is,

therefore, a present liability of an ascertainable amount which, of course, is ascertained on a later date after the close of the accounting year.

Therefore, the amounts set apart towards Income Tax liability so far as it is referable to the actual tax liability ultimately ascertained and recovered

cannot be said to be a reserve under Rule 1 of Schedule 2. But the excess provision for taxation, however, satisfies the test of a ""reserve"". It has

been appropriated towards a specific purpose and the same has been kept for the future use of the company.

The result, therefore, is the question referred in T.C. No. 261 of 1967 is answered in the affirmative and against the revenue. The question

referred in T. C. No. 260 of 1967 is answered in the affirmative and in favour of the assessee so far as items relating to bonus, excess provision for

taxation and the excess provision for development reserve are concerned. As regards the dividend and the actual liability for Income Tax, the

question is answered against the assessee. The assessee will be entitled to its costs, one set. Counsel''s fee Rs. 250.