Full Judgment Text
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 1 of 8
PETITIONER:
COMMISSIONER OF INCOME TAX, KANPUR
Vs.
RESPONDENT:
THE ELGIN MILLS LTD., KANPUR
DATE OF JUDGMENT31/07/1986
BENCH:
MUKHARJI, SABYASACHI (J)
BENCH:
MUKHARJI, SABYASACHI (J)
PATHAK, R.S.
CITATION:
1986 AIR 1943 1986 SCR (3) 398
1986 SCC (3) 663 JT 1986 7
1986 SCALE (2)112
ACT:
Companies (Profits) Surtax Act, 1964, Schedule 2 Rule
I-"Investment reserve", "rehabilitation reserve", "capital
reserve", "depreciation reserve" and "forfeited dividends"-
Whether statutory deductions-"provision" and "reserve"-
Distinction between.
HEADNOTE:
In Civil Appeal No. 1665 of 1974, a dispute arose
between the respondent-assessee and the Revenue with regard
to the computation of "standard deductions" under the
provision of Companies Profits (Surtax) Act, 1964. The
respondent-assessee claimed that the three amounts in
respect of three accounts, namely, (a) investment reserve
(b) rehabilitation reserve and (c) forfeited dividend
reserve should be treated as reserves for the purposes of
computation of its capital for the assessment year 1964-65
of which the relevant previous year ended on 30th Sept.,
1963. The Income-tax officer did not include any of the said
"reserves" in the capital of the respondent company on the
basis that these did not represent "reserve" in the real
sense. The matter, ultimately went before the Tribunal. It
held: (i) that all the three accounts represented "reserves"
for the purposes of assessment under the Super Profits Tax
Act, 1963 and as the principle involved was the same as
under the Companies Profits (Surtax) Act, 1964, the accounts
in question represented "reserves" under the latter Act
also. The High Court also, relying on its earlier decision
in Commissioner of Income-tax, Kanpur v. British India
Corporation (P) Ltd. 92 TIRE 38, affirmed the view taken by
the Tribunal and held (i) that under both the Acts charging
sections (s. 4) were identically worded except that
expression(Standard Deduction) in Super Profits Tax Act,
1963 had been replaced by the expression "statutory
deductions" in Companies Profits (Surtax) Act, 1964; (ii)
that under both Acts these deductions had to be computed
with reference to the capital employed in the assessee’s-
Companies; and (iii) that under both the Acts reserves of
the company were to be treated as its capital and the only
difference was in the
409
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 2 of 8
Second Schedule to the Companies Profits (Surtax) Act, 1964
where an A explanation had been added, and this explanation
merely clarified what was implicit in the Super Profit Tax
Act, 1963.
In C.A. No. 145 of 1976 the assessee-respondent had
shown capital of Rs.2,63,79,218 which included inter-alia
investment reserve, rehabilitation reserve, capital reserve,
depreciation reserve and forfeited dividends. The High Court
held that the first four items constituted reserves and the
forfeited dividends account did not represent reserve.
Dismissing the C.A. No. 145 of 1976 and allowing CA No.
1665 of 1974 in part,
^
HELD: 1.1 The conclusion of the High Court in CA 1665
of 1974 holding that the investment reserve and
rehabilitation reserve were reserves and were entitled to be
treated so under the relevant Act is right. But, in the
facts of the case, the High Court was not right in holding
that the "forfeited dividend reserve" was reserve. However,
in CA No. 145 of 1976, the Tribunal and the High Court had
rightly excluded "forfeited dividend account" from the
reserve. [417G-H; 418D]
2.1 The Supreme Court in Vazir Sultan Tobacco Co. Ltd.
v. Commissioner of Income Tax [1981] 132 TIRE, 559 held that
the expression "reserve" in Super Profits Tax Act, 1963 and
the Companies Profits (Surtax) Act, 1964 are in pari
materia. [413C-D]
2.2 The distinction between "provision" and "reserve"
is while the "provision" is a charge of profits which are
taken into account in the gross receipt of Profits and Loss
Account, "reserve" is an appropriation of profit to provide
for the asset which it represented. Reserve might be general
or specific reserve, what is required is that the amount
should be kept apart for one or the other purpose either
general or specific. The distinction between provision and
reserve must be found out bearing in mind the main features
of the reserve. These are: (i) it must be an appropriation
of profits, current or accumulated and not a charge against
the profits for the year; (ii) the conduct of the parties
must bear out that intention; (iii) it must not be to set
apart to meet any known liability-a liability known to exist
on the date of the balancesheet. [416A-C]
In the instant cases, keeping in view the aforesaid
tests, invest-
410
ment reserve, rehabilitation reserve, capital reserve and
depreciation reserve constituted "reserves" and are entitled
to be treated as such under Companies Profits (Surtax) Act,
1964. The "forefeited dividends" do not represent "reserve".
[417G-H; 418A-B]
Vazir Sultan Tobacco Co. Ltd. v. Commissioner of Income
Tax, [ ]981] 132 ITR 559; Metal Box Co. Ltd v. Their
Workmen, 73 ITR 53 at 67-68; and Commissioner of Income Tax
(Central) Calcutta v. Standard Vaccum oil Co., 59 ITR 685 at
698 relied upon.
Commissioner of Income-tax, Kanpur v. British India
Corporation (P) Ltd., 92 ITR 38 approved.
Commissioner of Income Tax v. Eyre Smelting Private
Ltd., 118 ITR 857 referred to.
JUDGMENT:
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1665 of
1974
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 3 of 8
From the Judgment and order dated 28.9.1973 of the
Allahabad High Court in I.T. Reference No. 195 of 1971.
With Civil Appeal No. 145 of 1976.
Dalip Singh, K.C. Dua and Miss A. Subhashini for the
Appellant.
Harish Salve, K.J. John, Ranjit Kumar and B.P. Singh
for the Respondent.
The Judgment of the Court was delivered by
SABYASACHI MUKHARJI, J. These two appeals were heard
together. Civil Appeal No. 1665 of 1974 arises from the
decision of the High Court of Allahabad in Income-Tax
Reference No. 195 of 1971.
The assessee, Elgin Mills Ltd., at the relevant time,
was a public limited company engaged in the business of
manufacture of textile goods. The assessment year involved
is the year 1964-65 of which the relevant previous year
ended on 30th September, 1963. For the purposes of
assessment under the provisions of Companies Profits
(Surtax) Act, 1964, a dispute arose between the assessee and
the revenue with regard to the computation of "Standard
deductions". The company claimed that the following amounts
should be treated as
411
reserves for the purposes of computation of its capital:
(a) Investment Reserve-Rs.85,00,000
(b) Rehabilitation reserve-Rs.40,00,000
(c) Forfeited Dividend reserve-Rs.96,374
The Income-tax Officer did not include any of the said
’reserves’ in the capital of the assessee-company on the
basis that these did not represent reserve in the real
sense. On appeal, the Appellate Assistant Commissioner held
that the Rehabilitation reserve and Forfeited Dividends
reserve represented reserves but the investment reserve
account did not constitute real reserve. Both the assessee
as well as the revenue went up in appeal before the
Tribunal. The Tribunal disposed of these appeals by a
similar order along with two similar appeals relating to the
assessment year 1963-64 which arose out of proceedings under
the Super Profits Tax Act, 1963. The Tribunal held that all
the three accounts represented reserves for the purposes of
assessment under the Super Profits Tax Act, 1963. The
Tribunal was further of the view that all the three
represented reserves for the purposes of assessment under
the Super Profits Tax Act, 1963 and as the principle
involved was the same as under the Companies Profits
(Surtax) Act, 1964, the Tribunal held that the accounts in
question represented reserves under the latter Act also. At
the instance of the Commissioner, reference was made to the
High Court for the assessment year 1964-65 on the following
questions:
"1. Whether, on the facts and in the circumstances
of the case, the tribunal was right in arriving at
its decision by applying the principles laid down
in the second schedule to the Super Profits Tax
Act, 1963, instead of the provisions of the second
Schedule to the Companies Profits (Surtax) Act,
1964, for computation of capital of the assessee
company for the assessment year 1964-65.
2. Whether, on the facts and in the circumstance
of the case, the tribunal was right in holding
that (a) Investment Reserve (b) Rehabilitation
reserve (c) Forfeited Dividend Reserve were
includible in the capital computation of the
company in accordance with the second schedule to
the Companies Profits (surtax) Act, 1964."
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 4 of 8
412
The High Court noted that in the connected reference
No. 196 of 1971-Commissioner of Income-tax v. Elgin Mills
Company Ltd. (decision dated 19th July, 1973)) arising out
of proceedings under the Super Profits Tax Act, 1963, it had
already held that these accounts in question constituted
reserve in the real sense and as such should be taken into
consideration in determining the standard deductions under
section 9(2) of the Act, 1963. It was not disputed before
the High Court that if the present reference had been under
the Super Profits Tax Act, 1963, the accounts in question
would have to be held as reserves by the High Court in view
of its previous judgment. But it was contended that the
provisions of the Companies Profits (Surtax) Act, 1964 were
different from the provisions of the Super Profit Tax Act,
1963. The High Court did not accept this contention. The
High Court was of the view that under both the Acts,
charging sections (section 4) were identically worded except
that the expression "standard deduction" in Super Profits
Tax Act, 1963 had been replaced by the expression "statutory
deductions" in the Companies Profits (Surtax) Act, 1964.
Under both Acts these deductions had to be computed with
reference to the capital employed in the assessee company.
Under both the Acts reserves of the company were to be
treated as its capital and the only difference was in the
second schedule to the Companies (Profits) Surtax Act, 1964,
an explanation had been added. The said explanation was to
the following effect:
"For the removal of doubts it is hereby declared
that any amount standing to the credit of any
account in the books of a company as on the first
day of the previous year relevant to the
assessment year which is of the nature of item (5)
or item (6) or item (7) under the heading
"RESERVES AND SURPLUS" or of any item under the
heading "CURRENT LIABILITIES AND PROVISIONS" in
the column relating to "Liabilities" in the Form
"Balance Sheet" given in part I of Schedule VI to
the Companies Act, 1956 (I of 1956), shall not be
regarded as a reserve for the purposes of
computation of the capital of a company under the
provision of this schedule."
This explanation, the High Court noted, merely
clarified what was implicit in the Super Profit Tax Act,
1963. Item No. S in the prescribed Balance Sheet under the
Companies Act is "Surplus ’ i.e.
Balance in profit and loss account after providing for
proposed alloca-
413
tions, namely, Dividend, Bonus, or Reserves. Item No. (6)
was "Proposed additions to reserves" and item No. (7) was
"Sinking Funds". The Accounts mentioned in the explanation
would not form a reserve for the purposes of the computation
of capital of a company. In any case the High Court was of
the view that none of the accounts in dispute fell under the
heading "current liabilities". It was contended before the
High Court on behalf of the revenue that any amount credited
to those accounts during the relevant previous year would
fall in item No. 6 viz. proposed additions to reserves. The
High Court found that there were no additions to those funds
during the relevant previous year inasmuch as the amount
standing in those accounts were being brought forward from
year to year. In those circumstances the Tribunal was right
in deciding the question with regard to the admissibility of
the three accounts in question on the principle application
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 5 of 8
to Super Profits Tax Act, 1963. This Court in Vazir Sultan
Tobacco Co. Ltd. v. Commissioner of Income Tax, [1981] 132
I.T.R. 559 held that the expression "reserve’. in Super
Profits Tax Act, 1963 and the Companies Profits (Surtax)
Act, 1964 are in pari materia.
On merits, it was agreed that the points were covered
by the previous decision of the High Court in the case of
Commissioner of Income-tax, Kanpur v. British India
Corporation (P) Ltd., 92 I.T.R. 38. Accordingly, the High
Court answered both the questions in the affirmative and in
favour of the assessee. This appeal arises out of the said
decision of the High Court. In Commissioner of Income-tax,
Kanpur v. British India Corporation (P) Ltd. (supra), the
High Court noted the distinction between ’provision’ and
’reserves’ and observed that when an amount was set apart
for a future liability, it was called a reserve and when it
was set apart to meet an existing liability, it was called a
provision. The High Court was of the view that the Tribunal
in that case was right in holding that capital reserve,
stocks and stores reserves, bad and doubtful debts reserves,
obsolescence reserve, loans and insurance reserves and
investment reserves were to be included in the computation
of capital. The Tribunal was not right in including,
according to the High Court, forfeited money reserve as the
assessee had been transferring to this account dividends
which had not been collected by the share holders after they
had been declared, and as and when the shareholders made a
claim, made payments and debited the same to the account.
The High Court, therefore, was of the view that this account
represented a provision in respect of an existing liability.
The High Court in Income-Tax Reference No. 196 of 1971
had to
414
deal with investment reserve account, rehabilitation reserve
account, capital reserve account and depreciation reserve
account and held that these were reserves but the account
maintained as dividend account did not represent reserve.
The High Court in its judgment noted that on the 19th
July 1973 relying on other judgment in Income-Tax Reference
No. 200 of 1917 Commissioner of Income-Tax v. The Saran
Engineering Co. Ltd. had answered the question by saying
that the aforesaid items were re serves. This is the subject
matter of civil appeal No. 1599 of 1974 which will also be
disposed of by another judgment of this Court.
Civil Appeal No. 1665 of 1974 and Civil Appeal No. 145
of 1976 which arose out of the Income-Tax Reference No. 196
of 1971 have been heard together and are being disposed of
by this judgment.
In this connection it would be desirable to dispose of
Civil Appeal No. 145 of 1976 separately first. It was
submitted that the assessee had shown capital of
Rs.2,63,79,218 which included the aforesaid reserves
including investment reserves, rehabilitation reserve,
capital reserve, depreciation reserve and forfeited
dividends. The submission on behalf of the revenue by Sree
Dalip Singh was that the amount of Rs.85 lakhs in the
relevant year as investment reserve was set apart by the
assessee company to meet the liabilities of its Bombay Sub-
sidiaries, M/s Madhav Mills Ltd. and Calico Processors Ltd.
which were known to the assessee on the date of the balance-
sheet. The Directors’ report, according to the revenue, left
no room for doubt that these were anticipated losses of the
assessee company in the form of the investments made in its
Bombay subsidiaries known at the date of the balance sheet.
These were liabilities, according to Sree Singh actually
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 6 of 8
staring in the face of the assessee company when it prepared
the balance sheet. The Tribunal had held that it was a
reserve because it was formed by transfer of the amount from
capital/General reserve. This according to the revenue,
could not be accepted. Revenue submitted that it was a
common ground that originally the amount was set apart out
of the undistributed mass of profits and therefore the
moment it was taken out of the capital or general reserve,
it ceased to be a capital or general reserve, and but for
its being set apart to meet the liabilities of its
subsidiaries, it had again gone back and formed part of the
undistributed mass of profits and thereby assumed its
original character. It was submitted that the reserve in
order that it might be so called in the real sense of the
term must come out of the profits of the
415
company. But if reserves were constituted out of assets
which were sold A or by any other means it would be
difficult to term the amounts shown as reserve. It was
submitted that the investments by the assessee company in
the Bombay subsidiaries were in the nature of bad and
doubtful debts. Therefore, these were dead losses of the
assessee company as the holding company, and these amounts
were ultimately bound to be writ- ten off and according to
the revenue’s submission, the substance of the matter
clearly was that the amount of RS.85 lakhs though shown as a
reserve, was, in fact, a provision to meet the anticipated
losses or bad and doubtful debts in the shape of investments
in the two subsidiaries aforesaid which were shown at the
date of the balance sheet.
For the assessee Sree Salve drew our attention to the
distinction between reserve and provision which has been
discussed in the decision of this Court in Metal Box Co.
Ltd. v. Their Workmen, 73 I.T.R. 53 at 67-68.
According to the revenue, the nature and object of the
subsidiary companies have to be kept in view and the
practical result, revenue contended before us, was that the
shareholders of the holding company whose share capital had
been employed for the floatation of the subsidiary companies
had not only no power to control the dealings of the
subsidiary companies but in fact had no knowledge of, nor
any right to the knowledge of or dealings of the subsidiary
companies.
The expressions ’Provision’ and ’Reserve’ are defined
in Schedule VI Part III to the Companies Act, 1956. In the
decision of this Court in Vazir Sultan’s case (supra) it has
been held that a provision was meant to provide for any
known liability and the substance of the matter had to be
kept in view. It was further submitted by Sree Singh that
the depreciation reserve could not be considered to be
reserve in the real sense at all. Forfeited dividends
reserve of R.S.. 1,08,771 had to be a provision.
On the other hand, on behalf of the revenue, it was
submitted that in order to constitute reserve, there must be
an appropriation of profits current or accumulated and not a
charge against the profits for the year. The conduct must
bear out the intention to create a reserve. It must not be
to set apart to meet any known liability, a liability known
but existing on the date of the balance-sheet. The
explanation ’reserve’ has been defined in the text books of
Accountancy which has been noted by this Court. It was urged
that it could not be disputed
416
that reserve might be general or specific reserve, what was
required was that amount should be kept aprat for one or the
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 7 of 8
other purpose either general or specific. The distinction
between provision and reserve must be found out bearing in
mind main features of the reserve. These are (1) It must be
an appropriation of profits, current or accumulated and not
a charge against the profits for the year. (2) The conduct
of the parties must bear out that intention. (3) It must not
be to set apart to meet any known liability-a liability
known to exist on the date of the balance sheet. Reference
in this connection may be made to the observations of this
Court in Vazir Sultan’s case (supra) at pages 569-70. The
Calcutta High Court in Commissioner of Income Tax v. Eyre
Smelting Private Ltd., 118 I.T.R. 857, noted the
characteristics of ’provisions’ as well as ’reserves’. It
held, inter alia, that provisions were made against
anticipated losses and contingencies, it held further that
an amount set aside of the profits designed to meet a
contingency or liability or commitment or diminution in the
value of the assets known to exist would be a reserve, and
an amount set aside to provide for a known liability to
which the amount cannot be determined with substantial
accuracy would be a provision. The said High Court differed
from the decision of the Allahabad High Court in British
India Corporation (P) Ltd. (supra) in respect of ’bad and
doubtful debts.’ Whether in respect of bad and doubtful
debts the account could be treated as reserve or provision
would depend upon the facts and circumstances of the case.
The distinction between ’provision’ and ’reserve’ has
been clarified by this Court in Metal Box Company of India
Ltd. v. Their Workmen (supra) at pages 67-68 which states as
follows:
"The next question is whether the amount so
provided is a provision or a reserve. 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 P. & L. 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
417
(see Spicer and Pegler’s Book-keeping and
Accounts, 15th A Edition, page 42). 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 pro- vide for any known
liability of which the amount cannot be determined
with substantial accuracy is a provision: (see
William Pickles Accountancy, second edition, p.
192; Part III, clause 7, Schedule VI to the
Companies Act, 1956: which defines provision and
reserve)."
This Court in Commissioner of Income Tax (Central)
Calcutta v. Standard Vaccum oil Co., 59 I.T.R. 685 at 698,
observed that the ordinary meaning of the expression reserve
http://JUDIS.NIC.IN SUPREME COURT OF INDIA Page 8 of 8
was something specifically kept apart for further use or for
specific occasion. The observations made therein will have
to be understood in the light of the subsequent decisions of
this Court in Metal Box (supra) and Vazir Sultan (supra).
This Court in Vazir Sultan Tobacco Co. Ltd. etc. v.
Commissioner of Income-tax etc. (supra) considered the
expression ’reserve’ in the Super Profits Tax Act, 1963 and
Companies (Profit) Surtax Act, 1964. It is not necessary to
set out all the conclusions of this Court.
Our attention was drawn to Datta’s on the Company Law
(Third Edition) at page 42 1. "Reserves" consist of
appropriations from profits and other surplus and retained
for future use. This, however, does not include any amount
which had been kept to meet any liability or diminution in
value of assets known to exist as on the date of the balance
sheet. The essence and substance of the matter has to be
kept in view.
As reiterated before, the distinction between
’provision’ and ’reserve’ is while the ’provision’ is a
charge of profits which are taken into account in the gross
receipt of Profits & Loss Account, ’reserve’ is an
appropriation of profit to provide for the asset which is
represented.
Keeping these tests and the facts of these appeals in
mind, we must hold that the conclusion of the High Court in
Civil Appeal No. 1665 of 1974 holding that the investment
reserve and rehabilitation reserve were reserves and were
entitled to be treated so under the relevant Act is right.
But in the facts of the case, the High Court was
418
not right in holding that the forfeited dividend reserve was
reserve and question No. 2 also in the affirmative. It
should have followed in this respect its previous decision
in respect of forfeited dividend reserve in Commissioner of
Income-Tax v. British India Corporation (supra). The appeal,
therefore fails, except on the point of "Forfeited Dividend
Reserve."
In Civil Appeal No. 145 of 1976, we are concerned with
five items as mentioned i.e. investment reserve,
rehabilitation reserve, capital reserve, depreciation
reserve and forfeited dividends and in view of the facts
found, we are of the opinion that first four items
constituted reserves and were entitled to be treated as such
under the Act and the forfeited dividends did not represent
reserve. This appeal accordingly fails in view of the facts
found by Tribunal and reiterated by the High Court and the
principles applicable as mentioned hereinbefore. The High
Court in its order had excluded "Forfeited dividend account"
from the reserve. The High Court was right in so doing.
In the facts and circumstances of the case, the parties
will pay and bear their own costs in both the appeals.
CA 1665/74 allowed in part.
M.L.A. CA 145/76 dismissed.
419