R. Ratnam vs Commissioner of Wealth-tax

Ramanujam, J.—The question referred to us by the Income Tax Appellate Tribunal u/s 27(1) of the Wealth-tax Act is this :

Whether, on the facts and in the circumstances of the case, the shares held by the assessee in the Madras Motor and General Insurance Co. Ltd.

has been valued in accordance with the Wealth-tax Act ?

The assessee held 50 shares of the face value of Rs. 100 each in a public limited company called the "" Madras Motor and General Insurance

Company Ltd. "", which carried on business of motor and general insurance. The shares of the company are not quoted in the share market. As on

the valuation dates, on March 31, 1960, and March 31, 1961, for the assessment years 1960-61 and 1961-62, respectively, the assessee had

valued these shares for the purpose of inclusion in his net wealth at their face value of Rs. 100 per share. The Wealth-tax Officer did not accept the

said valuation. He worked out their value on the basis of the balance sheet of the company as on December 31, 1959, for the assessment year

1960-61 as under:

Rs.

Share capital, 30,000 shares of Rs. 100 each 30,00,000

Reserve and surplus 14,80,000

Balance of funds and accounts 14,34,697

Proposed dividend 4,50,000

63,65,100

Less advance tax 2,95,036

Value of 30,000 shares 60,70,036

Value per share Rs. 202.33.

The same basis was adopted by the Wealth-tax Officer for the assessment year 1961-62 and the value per share as per the balance-sheet of

the company as on December 31, 1960, was arrived at at Rs. 231.72 per share. The Wealth-tax Officer . in arriving at the value of the share took

the amounts shown as ""balance of funds and accounts"" in the two balance sheets of the company as revenue reserve or appropriation of profit

which will enhance the intrinsic worth of the shares.

The assessee appealed to the Appellate Assistant Commissioner objecting to the above method of valuation. The assessee contended before

him that the sums standing to the credit of "" balance of funds and accounts "" had been set apart as per regulation 26, Part V of the Code of

Conduct prepared under the Insurance Act, that the 50% of the net premium in respect of fire and miscellaneous insurance, and 100% of the

premium income in respect of marine insurance had been statutorily fixed as the amount to be set apart as reserve for unexpired risks, that the

amount standing to the said reserve was not an appropriation of profit but it is a charge on the profits, that the amount so set apart every year had

been allowed as a deduction in the computation of the income of the company for Income Tax purposes, and that the Wealth-tax Officer was not

justified in treating the said reserve as a revenue reserve. The Appellate Assistant Commissioner did not accept the assessee''s contention. He held

that the said reserve created to meet the contingent liablility could be added to find out the intrinsic worth of each share. The assessee appealed to

the Income Tax Appellate Tribunal. It, however, upheld the computation of the value of the shares made by the Wealth-tax Officer.

The assessee contends before us that though the Wealth-tax Officer may be justified in taking the funds to the credit of "" reserve and surplus "" as

surplus profits, he was not justified in taking the amounts to the credit of "" balance of funds and accounts "" as surplus for purposes of finding out the

value of the shares, that the said amount has to be excluded in the computation of the intrinsic value of the share, as that amount really represented

the estimated value of an accrued liability, that it is not a contingent liability as is assumed by the taxing authorities, and that, therefore, it cannot be

treated as surplus or accumulated profits. The learned counsel also refers to Section 7 of the Wealth-tax Act particularly to Sub-section (2)(a)

which provides that where the assessee is carrying on business for which accounts are maintained by him regularly, the Wealth-tax Officer may,

instead of determining separately the value of each asset held by the assessee in such business, determine the net value of the assets of the business

as a whole having regard to the balance sheet of such business as on the valuation date and making such adjustments therein as may be prescribed,

and contends that by virtue of the said provision as well as the definition of "" net wealth "" in Section 2(m) if the net value of the assets of the

business of the insurance company as a whole is to be determined with reference to the balance-sheet of the company, the accrued liabilities of the

company have to be excluded. According to the assessee the amount set apart as a reserve for unexpired risks in each of the years is a trading

liability in general and, therefore, it cannot be added to the profits. It is pointed out that Rule 5(c) of the First Schedule (Insurance Business), to the

Income Tax Act of 1961 specifically allows such an amount carried over to a reserve for unexpired risks as may be prescribed as a deduction in

computing the profits and gains of any business of insurance other than life insurance, and that Rule 6(e) of the Income Tax Rules, 1962, prescribes

the limits of such reserves for unexpired risks at 50% of the net premium income in relation to fire or miscellaneous insurance and at 100% of the

net premium income in relation to marine insurance and that, even though such a provision was not there before the enactment of the Income Tax

Act, 1961, such a deduction was allowed in assessments under the Indian Income Tax Act, 1922, as well. Reference also is made to the

provisions of Section 11 of the Insurance Act, 1938, which enjoins on every insurer the duty of preparing and submitting a balance sheet in the

prescribed form. Form F of the Third Schedule which has prescribed the form of revenue account in relation to marine and miscellaneous insurance

business specifically directs the insurer to set apart as reserve for unexpired risks the required percentage of the premium income of the year. The

creation of a reserve for unexpired risks as per regulation 26 of the regulations contained in the Code of Conduct for general insurance business

framed by the General Insurance Council is compulsory in view of the said statutory provisions. It is, therefore, urged that the amount which had

been statutorily reserved for unexpired risks cannot be treated as surplus profits for the purpose of ascertaining the intrinsic worth of the shares in

question.

The learned counsel for the revenue, however, contends that the regulations contained in the Code of Conduct for general insurance business

framed by the General Insurance Council are not statutory, that in any event these regulations cannot govern the proceedings under the Wealth-tax

Act, that the deduction of such a reserve in relation to Income Tax assessments has been recognised only under the Income Tax Act of 1961, and

that the legal position cannot be construed to be the same even for the assessment years in question when the Income Tax Act of 1922 was in

force.

We are, however, of the view that the Code of Conduct for the general insurance business framed by the General Insurance Council is statutory.

Section 64-L of the Insurance Act, 1938, enumerates the functions of the executive committee of the General Insurance Council, and Section 64-

R empowers the General Insurance Council to frame regulations in respect of any matter which may be necessary for the purpose of enabling it to

carry out its duties under the Act, with the previous approval of the Central Government, Therefore, it is not possible to ignore the Code of

Conduct issued by the General Insurance Council as non-statutory, having no binding effect either on the insurance or on the taxing authorities. The

question, therefore, is whether the separate reserve credited for unexpired risks as required by the Insurance Act and the Code of Conduct can be

treated as surplus profits by the authorities under the Wealth-tax Act, for purpose of determining the intrinsic value of shares of the insurance

company in question.

In Sun Insurance Office v. Clark, [1912] 6 T.C. 59, a company carrying on business of fire insurance, had made a practice of carrying forward

annually, in its published accounts, as a reserve, 40 per cent, of the yearly premium receipts representing estimated losses on unexpired risks, and

had claimed to be assessed on that basis. The court held that, notwithstanding the absence of any rule of law as to the admissibility of an allowance

for unexpired risks in estimating profits, on the facts found the allowance claimed was a proper allowance, overruling the contention of the revenue

that the company was not legally entitled to such an allowance. In Commissioner of Income Tax, West Bengal, Calcutta Vs. Calcutta Hospital and

Nursing Home Benefits Association, the Supreme Court had to deal with a mutual insurance business carried on by the assessee. In that case the

assessee in its balance sheet and profit and loss account made a provision for taxation in the form of a reserve. The Income Tax Officer added the

said reserve to the general revenue reserve for taxation purposes. The Supreme Court held that as per Rule 6 of Schedule I to the Income Tax

Act, 1922 (corresponding to Rule 5 of Schedule I to the Act of 1961) the profits and gains of any business of insurance other than life insurance

shall be taken to be the balance of the profits disclosed by the annual accounts as furnished to the Superintendent of Insurance and that, therefore,

the Income Tax Officer is bound to accept that balance of receipts as disclosed by the annual accounts as submitted to the Superintendent of

Insurance. In Metal Box Company of India Ltd. Vs. Their Workmen, the Supreme Court, while dealing with a reserve created by the assessee to

meet its liability under a scheme of gratuity in respect of the accounting year, held that a reserve which is the estimated liability for the year on

account of a scheme for gratuity should be allowed to be deducted from the gross profits and the allowance cannot be restricted to the actual

payment of gratuity during the year. In that case it was held that contingent liabilities discounted and valued can be taken into account as trading

expenses if they are sufficiently certain and capable of valuation, that profits cannot be properly estimated without taking them into consideration,

that estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross receipts

while preparing the profit and loss account, that there is nothing in the Bonus Act which prohibits such a practice, and that such a provision

provides for a known liability of which the amount can be determined with substantial accuracy. In that case their Lordships of the Supreme Court

referred to the earlier decision of its own in Calcutta Company Ltd. Vs. The Commissioner of Income Tax, West Bengal, as laying down the

proposition that, having regard to the accepted commercial practice and trading principles and there being no prohibition against it in the Income

Tax Act, deduction of such estimated liability, even though it did not come under any specific provision of Section 10(2) of the Income Tax Act,

1922, was permissible. Their Lordships of the Supreme Court had also expressed the view that such a deduction of an accrued liability on an

estimated basis though not actually paid is not confined to the Income Tax Act but is also permissible under the Wealth-tax Act, 1957. In Kesoram

Industries and Cotton Mills Ltd. Vs. Commissioner of Wealth Tax, (Central) Calcutta, a question arose as to whether the amount of dividend

proposed to be distributed for the year and the amount set apart as a provision for tax liability under the Income Tax Act were debts and could be

deducted while computing the company''s net wealth. It was held by the Supreme Court that the dividend amount was not a debt as on the

valuation date, but the amount set apart as the estimated tax liability was a debt inasmuch as the liability to pay the tax was in praesenti though

payable in future and was in respect of an ascertainable sum of money.

In Standard Mills Co. Ltd. Vs. Commissioner of Wealth-tax, Bombay City, the Supreme Court considered the question whether an estimated

liability under the gratuity scheme framed under the industrial awards amounted to a debt and could be deducted while computing the net wealth,

and it was held that in view of the terms of Section 2(m) of the Wealth-tax Act, as the liability to pay a gratuity was not in praesenti but would arise

in future on the termination of service, it was not a debt and the liability is only a contingent liability. In a recent decision of the Privy Council in

Guiana Industrial and Commercial Investments Ltd. v. Inland Revenue Commissioners (No. 2), [1971] A.C. 841 (P.C.) the question arose as to

whether in computing the amount of "" net property "" the amount set apart as a provision for Income Tax is deductible from the total value of the

assets of the company as being a liability, and the deduction was disallowed on the ground that it was not a "" debt owed "" within the meaning of

Section 3 of the Property Tax and Gift Tax Ordinance, 1962, as no Income Tax was payable until an assessment was made for the year of

assessment and until the end of the year it could not be asserted that the company owed a debt for Income Tax. The court overruled the contention

of the company that although the Income Tax had not been actually assessed and was, therefore, then not payable, it was nevertheless a liability

which then existed. Section 3 of the said Ordinance corresponds to the definition of "" net wealth"" in our Wealth-tax Act. These cases are strongly

relied on by the revenue. But, in our view, these decisions will only show that the alternative contention of the learned counsel for the assessee that

the liability towards the unexpired risks in the succeeding year will be a debt due by the company and as such it will go to reduce the net value of

the asset u/s 2(m) of the Act cannot be accepted. According to the above decisions a "" debt owed "" has a clear primary legal meaning and must be

given that meaning in construing the statute. The significance of the debt is a sum of money due by an express agreement or where the debt arises

out of a statute by an implied agreement. There must be a fixed sum which the debtor is presently obliged to pay whether immediately or in future

subject to no contingency. The contingent liabilities have to be contrasted with debts owed.

In Life Insurance Corporation Ltd. Vs. Commissioner of Income Tax, Delhi and Rajasthan, the Supreme Court considered the scope of the

powers of the Income Tax Officer in the computation of profits and gains on a life insurance business. It has been expressed that the officer has to

accept only the average of the surplus disclosed by the actuarial valuation made in accordance with the Insurance Act in respect of the last inter-

valuation period so as to exclude therefrom any surplus or deficit included therein which was made in the earlier inter-valuation period, that he has

no power to check the figures in the accounts of the assessee, and that under Rule 3 the officer can make adjustments in the actuarial valuation

made by the assessee in it within a limited field, and that the adjustment of the profits of an insurance business is completely governed by the rules

in the Schedule to the Income Tax Act, and that the Income Tax Officer has no power to do anything not contained in it, there being no general

power to correct the errors in the accounts of an insurance business. The relevant observations are these :

It is clear that the Income Tax Act contemplates that the assessment of insurance companies should be carried out not according to the ordinary

principles applicable to business concerns as laid down in Section 10, but in quite a different manner. Insurance companies do not compute their

profits in the ordinary way because premiums cover risks which run into future years and loss includes losses from previous years. The method

prescribed ensures that by taking the average of several years a fair and reasonable conclusion is reached. Actuarial estimation plays an important

part and surplus only results when there is an excess of the fund over the liability after all other charges are met.

It is in the light of these decisions we have to consider the question as to whether the amount standing to the credit of "" balance of funds and

accounts "" has to be taken as surplus profits or revenue reserve for valuing the shares in question.

Section 7 of the Wealth-tax Act provides that the value of any asset other than cash shall be estimated to be the price which in the opinion of

the Wealth-tax Officer it would fetch if sold in the open market on the valuation date. Ordinarily, each asset has to be valued separately at its

market value on the valuation date and the result aggregated. It is not possible to evolve any precise criterion for estimating the market value of all

kinds of assets. The Central Board of Revenue by its Circular No. 3 WT of 1957, dated September 28, 1957, gave certain instructions as useful

guide to the officers in regard to the value of various types of assets (vide 33 ITR 97). Instruction 1(c) of that circular states that in the case of

shares which are not quoted on the stock exchange and for which the market value cannot be ascertained on the basis of stock exchange

quotation, the following method of valuation may be adopted, [1958] 33 ITR 97:

The total wealth of the company without excluding the values of any assets which would have been exempted in making the assessment on the

company to wealth-tax should first be determined. This will be determined by adding to the paid up capital the debentures, reserves and the

balance as per profit and loss account. The provision for. liabilities in the balance-sheet should particularly be scrutinised with a view to excluding

therefrom items which should really form part of the reserves. From the total so arrived at, the paid up value of the preference shares and the

debentures should be subtracted. The resulting balance should be divided by the amount of paid up ordinary share capital in order to arrive at the

value of each rupee of paid up capital. On multiplying this result by the paid up value of the shares held by the assessee their value is arrived at for

the purpose of wealth-tax assessment.

As already stated, in respect of the assessments under the Income Tax Act though there was no specific provision such as Rule 5(c) of

Schedule I to the Income Tax Act, 1961, the amounts carried over to a reserve for unexpired risks as per the provisions of the Insurance Act was

usually allowed as a deduction in the assessment of insurance companies. This appears to be clear from the Circular No. 929-1(2) 48, dated

November 24, 1952, issued by the Controller of Insurance which states that the Income Tax authorities allow up to 50% in the case of fire and

miscellaneous insurance and up to 100% in the case of marine insurance to be deducted as a reserve for unexpired risks for the purposes of

assessing Income Tax even in respect of assessments under the Indian Income Tax Act, 1922. The learned counsel for the assessee contends that

the statutory reserve for unexpired risks is not a contingent liability, but is in the nature of an accrued liability which has been quantified and

evaluated at 50% of the premium income in respect of fire and miscellaneous insurance and 100% in respect of marine insurance, that such an

evaluated or discounted liability is a liability in praesenti and not in future and that, therefore, such a liability has to be excluded before the profit of

the business is arrived at, It is stated that the liability is certain and not contingent, and that it is only the quantum of the liability that has to be

determined later. The learned counsel points out the distinction between a contingent liability and a payment dependent upon a contingency and

states that the insurers are entitled to estimate the present value of the future payment dependent upon a contingency and deduct such estimated

value before the profits of the business are ascertained. Reference was made to Southern Railway of Peru v. Owen, [1957] 32 ITR 737; [1957]

A.C. 334 ; [1956] 36 T.C. 602 (H.L.) wherein Lord Oaksey had stated :

There is, in my opinion, a fundamental distinction between a contingent liability and a payment dependent upon a contingency. When a debt is not

paid at the time it is incurred its payment is, of course, contingent upon the solvency of the debtor but the liability is not contingent.

In that case the earlier decision in Sun Insurance Office v. Clark, [1912] 6 T.C. 59 (H.L.) was referred to with approval by Lord Radcliffe.

According to the learned counsel for the assessee the decision in Metal Box Company of India Ltd. v. Their Workmen applies to the facts of

this case, while the revenue seeks support from the decision in Standard Mills Co. Ltd. Vs. Commissioner of Wealth-tax, Bombay City, . The

crucial question is to find out whether the reserve for unexpired risks is towards a contingent liability or whether it is towards a liability certain, the

quantum or the extent of which would be known in future. As pointed out in Sun Insurance Office v. Clark , though the liability of the insurer to

each of the policy-holder is contingent which may or may not arise, the overall liability towards the collective risk was a matter of commercial

certainty and a reasonable estimate of such collective risk has to be allowed as a deduction for ascertaining the true profits and gains of the

business in any particular year. In Metal Box Company of India Ltd. Vs. Their Workmen, their Lordships of the Supreme Court had pointed out

the distinction between a provision and a reserve thus :

The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and

contingencies are charges against profits, and, therefore, to be taken into account against gross receipts in the profit and loss account and the

balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of

the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which

they are made whereas general reserves and reserve funds are shown as part of the proprietor''s interest. An amount set aside out of. profits and

other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-

sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be

determined with substantial accuracy is a provision.

The question still remains as to whether the liability towards unexpired risks is a liability which is certain but its extent alone will have to be

ascertained on a future date. Having regard to the nature of the insurance business, it cannot be said that in respect of the collective risk undertaken

by the company the liability is contingent. The collective liability is sure to arise and it is only the extent of the liability that will vary in any year.

Though the liability towards a particular policyholder may be contingent, the cumulative or collective liability of the insurer towards its policyholders

in general is a liability certain and the extent of the liability will depend upon the contingencies that will take place in respect of each of the

policyholders in a particular year. As a matter of fact, from the profit and loss account filed in relation to the assessment years in question it is seen

that as against the reserve for unexpired risks the amount of claims paid under policies during the succeeding year is far in excess. The reserve

which amounts to a provision for a liability certain cannot be treated as a revenue reserve as contended by the revenue. According to the revenue,

the reserve for unexpired risks is not a fund and the Insurance Act itself makes a distinction between the balance of fund and the balance of

accounts. It is urged by the revenue that the reserve for unexpired risks which has not been treated as fund under the provisions of the Insurance

Act will have to be taken as a revenue reserve.

We are not inclined to agree with the contention put forward on behalf of the revenue. We are of the view that the principles laid down in

Metal Box Company of India Ltd. Vs. Their Workmen, applies to the facts of this case and that, therefore, the profits of the company in which the

assessee holds the shares in question can properly be determined only after making a provision for the unexpired risks which the company is bound

to do under the provisions of the Insurance Act and which was usually deducted from the gross profit for the purpose of ascertaining the net profit

under the executive instructions earlier and later under Rule 5(c) of Schedule I to the Income Tax Act, 1961. We are, therefore, of the view that

the Wealth-tax Officer is not justified in taking the amount under the head "" balance of funds and accounts "" as a revenue reserve or as surplus

profits. However, we find that the Wealth-tax Officer is justified in not taking the face value of the shares as the basis of valuation and taking into

account the amounts standing under the head "" Reserve and surplus "" for finding out the intrinsic value of the shares. We, therefore, answer the

question in the negative and in favour of the assessee.

The result will be that the Tribunal has to work out the intrinsic value of the shares after excluding the amounts standing to the credit of

balance of funds and accounts "" in each of the years. The assessee will have his costs. Counsel''s fee Rs. 250.