Full Judgment Text
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PETITIONER:
INDIAN TUBE CO. (P) LTD
Vs.
RESPONDENT:
COMMISSIONER OF INCOME-TAX, CALCUTTA
DATE OF JUDGMENT14/01/1992
BENCH:
RAMASWAMY, K.
BENCH:
RAMASWAMY, K.
JEEVAN REDDY, B.P. (J)
CITATION:
1992 SCR (1) 22 JT 1992 (1) 112
1992 SCALE (1)26
ACT:
Companies (Profit) Sur Tax Act, 1964 Sections-2 (b),
4,18-Payment of dividend-Recommendation of Board of
Directors-Whether reserve-Whether to be taken into
consideration for computation of capital.
HEADNOTE:
This appeal arises out of proceedings initiated to
compute the capital of the appellant-company for the purpose
of Sur-tax. The previous year relevant to the assessment
year of the paid up capital, the reserve, the debentures
etc. under Rule 1 of Second Schedule to the Surtax Act is
the calendar year 1963. The assessment year is 1964-65.
The position of the capital was to be considered as on the
Ist day of January, 1963. In this connection it may be
mentioned that the Directors of the appellant-assessee’s
company at their meeting held on 1.5.1963 approved the
transfer of a sum Rs. 90,00,000 out of the profits for the
1962 year to a ‘ Dividend Reserve Account’, 12 1/2% which
amounted to Rs. 76,00,000 on the ordinary shares on the
amount paid on those shares prior to 31.12.1962. On
31.5.1963 in the general meeting the accounts were passed by
the share-holders and the dividend as recommended by the
Directors was declared. Subsequently, the dividend was paid
and it was adjusted by transferring Rs. 76,00,000 from the
dividend reserve account through the Profit and Loss
Appropriation Account. The question therefore arose whether
a sum of Rs. 90,00,000 or any part thereof would be reserve
for computing the capital as on January 1,1963. The
appellant claimed in its assessment a sum of Rs. 90,00,000
transferred to the dividend reserve as a reserve entering
into capital computation. The assessing authority excluded
this sum from the computation of the capital but on appeal
the Appellate Assistant Commissioner found it to be a
reserve created out of amounts which had not been allowed as
deduction for computing the profits of that year. He
therefore held that Rs. 90,00,000 was the reserve fund
qualified for inclusion under Rule 1 (III) of the Second
Schedule to the Sur-tax Act. On appeal by the Revenue, the
Income-tax Appellate Tribunal held that "the assessee had
appropriated Rs. 76,00,000 out of the Year’s profit and
transferred the balance of Rs. 14,00,000 to the dividend
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reserve" : Rs. 76,00,000 was taken as liability as on
1.1.1963 and as the creation of Rs. 90,00,000 was
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to be taken as reserve on 1.1.1963, only a sum of Rs.
14,00,000 has been transferred to the reserve account.
Accordingly the Tribunal held that a sum of Rs. 14,00,000
would only be treated as a reserve and directed modification
of the capital computation. On a reference under section
256(1) of the Income-tax Act and Section 18 of the companies
(Profits) Sur-tax Act, 1964 at the behest of the appellant,
the High Court answered the question in the negative and
against the assessee. Hence this appeal by certificate
under Section 261 of the Income-Tax Act, 1961.
Dismissing the appeal, this Court,
HELD : A conjoint reading of the scheme of the Sur-tax
Act and the Company’s Act suggests that the appropriation
made by the Board of Directors by recommending payment of
dividend, in the nature of things does not constitute a
reserve. [28B]
If an amount is satisfied out of profits and other
surpluses, not to meet the liability, contingency,
commitment or diminution in the value of assets known to
exist at the time of the balance-sheet, it was a reserve.
The amount set aside out of profits and other surpluses to
profit for any known liability for which the amount could be
determined with certainty, it is a provision. [27H]
Creating of reserve out of the profit is a stage
distinct in point of fact and anterior in point of time to
the stage of making recommendation for payment of dividend
by the general body of the shareholders. [28A]
The true nature and character of the disputed sum,
therefore must be determined with reference to the substance
of the matter and not by the mere entry or nomenclature
which the assessee company had chosen to be given. [27G]
A sum of Rs. 76,00,000 worked out for the payment of
dividend and appropriated by subsequent resolution was only
a provision and the residue of Rs. 14,00,000 was reserve.
[28C]
Though the general body of the shareholders resolved
and appropriated on May 31,1963 of the dividend of Rs.
76,00,000 from the reserve of Rs. 90,00,000 it related back
to the relevant assessment year, and therefore, as on Ist
January, 1963, Rs. 76,00,000 was provision and cannot be
computed as capital. Only Rs. 14,00,000 would be treated
to be reserve. [30F-G]
Metal Box Co. of India Ltd. v. Their Workmen; 73
I.T.R. 53; Commis-
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sioner of Income-tax, Mysore v. Mysore Electrical Industries
Ltd., 1971 (80) I.T.R. 566; Hyco Products (P) Ltd. v.
Commissioner of Income-tax, Bombay referred to.
Vazir Sultan Tobaccoo Co. Ltd. v. Commissioner of
Income-tax, A.P. [1981] 132 I.T.R. 559, not applicable
JUDGMENT:
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 1254
(NT) of 1976.
From the Judgment and Order dated 23.8.1974 of the
Calcutta High Court in Income Tax Reference No. 241 of 1970
Janaki Ramachandran, R. Ayyam Perumal and D.N. Gupta
for the Appellants.
Dr V. Gauri Shankar, P Parmeshwaran, S. Rajappa and Ms.
A. Subhashini for the Respondents.
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The Judgment of the Court was delivered by
K. RAMASWAMY,J. This appeal, by certificate under
Section 261 of the Indian Income-tax Act 1961 (for short
‘the Act’) granted by the Calcutta High Court, arises from a
reference under Section 256 (1) of the Act and Section 18 of
the Companies (Profits) Sur-tax Act, 1964 (for ‘Sur-tax
Act’) on the question of law which was answered in negative
and against the appellant thus :
"Whether on the facts and in the circumstances
of the case the Tribunal was right in holding that
a sum of Rs. 76,00,000 which was paid as dividend
for the year 1962 following the General Meeting
dated 31st May, 1963 out of the dividend reserve
of Rs. 90,00,000 as on the Ist January, 1963 was
not to be taken into account for the computation
of capital as on the Ist January, 1963 in
pursuance of the rules of the Second Schedule to
the Companies (Profits) Sur-tax Act 1864."
The previous year relevant to the assessment year, of
the paid up capital, the reserve, the debentures etc. under
Rule 1 of second Schedule to the Sur-tax Act, is the
Calendar Year 1963. The assessment year is 1964-65. The
position of the capital was to be considered as on the Ist
day thereof i.e. 1.1.1963. The appellant claimed in its
assessment a sum of Rs. 90,00,000 transferred to the
dividend reserve as a reserve entering into capital compu-
25
tation. The assessing authority excluded this sum from the
computation of the capital but on appeal the Appellate
Asstt. Commissioner found it to be a reserve created out of
amounts which had not been allowed as deduction for
computing the profits of that year. Accordingly he held
that Rs. 90,00,000 was the reserve fund qualified for
inclusion under Rule 1 (III) of the Second Schedule to the
Sur-tax Act. On appeal by the Revenue, the Income-tax
Appellate Tribunal held that "the assessee had appropriated
Rs. 76,00,000 out of the year’s profit and transferred the
balance of Rs. 14,00,000 to the dividend reserve" : Rs.
76,00,000 was taken as liability as on 1.1.1963 and as the
creation of Rs. 90,00,000 was to be taken as reserve on
1.1.1963 only a sum of Rs. 14,00,000 has been transferred to
the reserve account. Accordingly the Tribunal held that a
sum of Rs. 14,00,000 would only be treated as a provision
and directed modification of the capital computation
accordingly. On reference at the behest of the appellant the
High Court answered the question in the negative and against
the assessee.
Section 4 of the Sur-tax Act, the charging section
postulates that, subject to the provision contained therein,
there shall be a charge on every company for very
assessment year commencing on and from the Ist day of April,
1964, a tax in respect of so much of its chargeable profits
of the previous year or pervious years as the case may be as
exceeds the statutory deduction, at the rate or rates
specified in the Third Schedule. Section 2 (5) defines
chargeable profits as a total income of an assessee computed
under the Act for any previous year or years as the case may
be and adjusted in accordance with the provisions of the
First Schedule. Section 2 (8) accords statutory deduction,
an amount equal to 10 per cent of the capital of the company
as computed in accordance with the provisions of the Second
schedule or an amount of Rs. 200 thousands whichever is
greater. The First Schedule provides the rules for
computation of the chargeable profits. The Second Schedule
gives the procedure to compute the capital of the company
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for the purpose of sur-tax. Rule 1 of the Second Schedule
postulates that, subject to the other provisions contained
in the Second Schedule, the capital of a company shall be
the aggregate of the amounts as on the first day of the
previous year, relevant to the assessment year of its paid
up share capital, its reserve, if any, and other reserves as
reduced by the amounts credited to such reserves as have
been allowed as a deduction in computing the income of the
company for the purpose of the Indian Income-tax Act, its
debentures; if any, or any borrowed amounts. The
explanation thereto provides thus :
"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
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Year which is of the nature of item (5) or item
(6) or item (7) under the heading "Reserves and
Surplus" of any item under the heading "Current
Liabilities and Provision" in the column relation
to "Liabilities’ in the ‘Form of Balance Sheet"
given in Part 1 of the Schedule VI to the
Companies Act, 1956 (1) or of 1956 shall not be
regarded as a reserve for the purpose of
computation of the capital of a company under the
provisions of this schedule."
Section 217 of the Companies Act, 1956 enjoins the
company to attach to every balance sheet laid before a
company general meeting, a report by its Board of Directors,
with respect to :
(a) the state of the company’s affairs;
(B) The amounts, if any, which it proposes to carry to
any reserves in such balance sheet; and
(c) the amount, it any, which it recommends should be
paid by way of dividend;......"
Regulation 87 of table A of the First Schedule empowers
the Board to recommend any dividend set aside, out of the
profits of the company, such sum as it thinks proper as a
reserve or reserves etc.
It is found as a fact that on Ist May, 1963 in respect
of the accounts for the year 1962 in the Director’s meeting
of the assessee company it approved the transfer of a sum of
Rs. 90,00,000 out of the profits for the year to a ‘Dividend
Reserve Account’ 12-1/2% which amounted to Rs. 76,00,000 on
the ordinary shares on the amount paid on those shares prior
to 31st December, 1962. On 31st May, 1963 in the general
meeting the accounts were passed by the shareholders and the
dividend as recommended by the Directors was declared.
Subsequently, the dividend was paid and it was adjusted by
transferring Rs. 76,00,000 from the dividend reserve account
through the Profit and Loss Appropriation Account.
In its report, the Board of Directors stated that the
Auditor’s Report presented the ‘company affairs as on 31st
December, 1962 and its profits for the year ended on that
date’. In the balance sheet under the heading ‘Liabilities’
as on 31st December, 1962 under the sub heading ‘Provisions’
item (c) "Proposed Dividend" shows the figure "to be nil".
The Schedule forming part of the balance sheet under the
head ‘Reserve and Surplus’ under item (e) the Dividend
Reserve Account stated that from the transfer of a Profit
and Loss Account was Rs. 90,00,000
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The question, therefore, is whether a sum of Rs.
90,00,000 or any part thereof would be reserve for computing
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the capital as on January 1, 1963. From the above fact, it
is clear that a sum of Rs. 76,00,000 earmarked by the
director’s recommendation dated May 3,1963 as dividend, was
approved by the general body meeting of the shareholders on
May 31, 1963 and the same was paid over to the shareholders
and in the balance sheet this liability was treated as on
December 31, 1962 to be nil. The purpose of the Sur-tax Act
is to impose Sur-tax on the profits of a company. The Act
also intended to impose tax on the net profits after
allowing deductions in terms of the Sur-tax Act and the
procedure for computation thereof was indicated in the 2nd
schedule. In the computation, the profits, the capital or
reserve forming capital of the company, had to be excluded.
It is well known that the accounts of the company have to be
brought up for a year upto a particular date. On the facts
of this case the crucial date is 1.1.1963. If it was
reasonably practicable to make up the accounts as on that
date and present the same to the directors of the company as
on December 31, 1962 and the balance sheet thereof is placed
before the general body meeting of the share-holders as on
that date, they could have made up their minds on that date
and declared their intention of appropriating the dividend
or any other sums to reserves of different heads of
liabilities. But the fact remains that it was not done for
the obvious reason that the calculation or collection of the
figures of all the items of income and expenditure of the
company of the previous year ending December 31, 1962 was
bound to take some time and it was not done. The fact
remains that the shareholders in the general body meeting
held on May 31,1963 resolved to appropriate Rs. 76,00,000
towards dividend payable to the shareholders and accordingly
it was appropriated and paid over. The question, therefore,
is whether the amount of Rs. 76,00,000 appropriated relates
back as on January 1,1963. On recommendation by the Board
of Directors and acceptance thereof by the general body of
the shareholders to pay dividend at a particular percentage,
the liability came into existence and by their act of
appropriation by adjusting the reserve as against the
liability it became crystalised. There is nothing to
withhold payment in species to the respective shareholders
which is merely a ministerial act. The modus operandi
adopted in making the entries or nomenclature chosen to be
given are not conclusive but the heart of the matter is the
nature and substance of the manner in which the company’s
accounts are prepared. The true nature and character of the
disputed sum, therefore, must be determined with reference
to the substance of the matter and not by the mere entry of
nomenclature which the assessee company had chosen to be
given. If an amount is satisfied out of profits and other
surpluses, not to meet the liability, contingency,
commitment or diminution in the value of asset known to
exist at the time of the balance sheet, it was a reserve.
The amount set aside out of profits and
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other surpluses to profit for any known liability for which
the amount could be determined with certainity, it is a
provision. Creating of reserve out of the profit is a stage
distinct in point of fact and anterior in point of time to
the stage of making recommendation for payment of dividend
by the general body of the shareholders. A conjoint reading
of the scheme of the Sur-tax Act and the company’s Act
suggests that the appropriation made by the Board of
Directors by recommending payment of dividend, in the nature
of things does not constitute a reserve. The resolution by
the general body of the shareholders to make dividend out of
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profits at a particular percentage crystalised into a
liability, and subsequent payment relates back to the
relevant date, namely, closing of the accounting year
during which the liability had arisen. Therefore, the
resolution of the general body of the shareholders dated May
31, 1963 had retrospective effect inasmuch as it refers to
the profits of the previous year ending December 31, 1962.
Therefore, a sum of Rs. 76,00,000 worked out for the payment
of dividend and appropriated by subsequent resolution was
only a provision and the residue of Rs. 14,00,000 was
reserve.
In Metal Box Co of India Ltd. v. Their Workmen, 73
I.T.R. 53 this Court was concerned whether appropriation
amounted to reserve or provision. Dealing with the question
of payment of bonus to the workmen and appropriation thereof
on that account, this Court held that the distinction
between a provision and a reserve was in commercial
accountancy fairly well known. Provision were made against
anticipatory losses and contingencies were charged against
profit and they had been taken into account against gross
receipts in the profit and loss account and balance sheet.
On the other hand, reserves were appropriation of profits,
the assets by which these were represented being retained to
form part of capital employed in their business. provisions
were usually shown in the balance sheet by deduction from
the asset in respect of which those were made whereas
general reserve and reserve fund were shown as part of
proprietor’s interest. An amount set aside out of profits
and other surpluses, not designed to meet a liability,
contingency, commitment or diminution in valuation of asset
known to exist on the date of the balance sheet was a
reserve but an amount set aside out of profits and other
surpluses, was provided for known liability for which the
amount could not determined with substantial accuracy was a
provision. In Commissioner of Income-tax, Mysore V. Mysore
Electrical Industries Ltd. 1971 (80) I.T.R. 566 a
constitution bench of this Court held that the
determination of the directors to appropriate the accounts
to the three times of reserve on August 8, 1963 had to be
related to April 1, 1963 i.e. the beginning of the accounts
in the new year and had to be treated as effective from that
date and the three items had to be added to the other times
for computation of the capital of the respondent as on April
1, 1963 under Rule
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1 of Schedule II of the Sur-tax Act. In that case the
Revenue contended that since the appropriation was made
after the accounting year it would not relate back to the
assessment year. Rejecting that contention this Court held
that although such allocation was factually not possible on
the very first day of a year but allocation on a later day
should be treated as effective from that date in view of the
fact that the division of undistributed profits became
effective from that date. The case of Vazir Sultan Tobaccoo
Co Ltd. v. Commissioner of Income-tax, A.P. 1981 [132] ITR
559, relied on by the assessee, far from helping the
appellant, goes against the contention of the learned
counsel for the appellant. Construing Section 217 of the
Company’s Act 1956 and the Schedule this Court held thus :
"On a plain reading of cl. 7(1) (a) and (b) and
cl. 7(2) above it will appear clear that though
the term ‘provision’ is defined positively by
specifying what it means the definition of
‘reserve’ is negative in form and not exhaustive
in the sense that it only specifies certain
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amounts which are not to be included in the term
‘reserve’ In other words the effect of reading the
two definitions together is that if any retention
or appropriation of a sum falls within the
definition of ‘provision’ it can never be a
reserve but it does not follow that if the
retention or appropriation is not a provision it
is automatically a reserve and the question have
to be decided having regard to the true nature and
character of the sum so retained or appropriated
depending on several factors including the
intention with which and the purpose for which
such retention or appropriation has been made
because the substance of the matter is to be
regarded and in this context the primary
dictionary meaning of the term ‘reserve’ may have
to be availed of. But it is clear beyond doubt
that if any retention or appropriation of a sum is
not a provision, that is to say, if it is not
designated to meet depreciation, renewals or
diminution in value of assets or any known
liability the same is not necessarily a reserve.
We are emphasising this aspect of the matter
because during the hearing almost all counsel for
the assessee strenuously contended before us that
once it was shown or became clear that the
retention or appropriation of a sum out of profits
and sur-pluses was for an unknown liability or for
a liability which did not exist on the relevant
date it must be regarded as a reserve. The
fallacy underlying the contention becomes apparent
if the negative and non-exhaustive aspects of the
definition of reserve are borne in mind. Having
regard to the type of definitions of the two
concepts which are to be found in cl. 7 of pt.
III the proper
30
approach in our view would be first to ascertain
whether the particular retention or appropriation
of a sum falls within the expression
‘provision’ and if it does then clearly
the concerned sum will have to be
excluded from the computation of capital, but in
case the retention or appropriation of the sum is
not a provision as defined, the question will have
to be decided by reference to the true nature and
character of the sum so retained or appropriated
having regard to several factors as mentioned
above and if the concerned sum is in fact a
reserve then it will be taken into account for the
computation of capital".
This Court in Hyco Products (P) Ltd. v. C.I.T. Bombay
(supra) approved the ratio of the Bombay High Court in Ref.
case No. 5 of 1978 of Hyco Products (P) Ltd. Bombay. The
question therein relates to the assessment year 1974-75.
The relevant provision being the calendar year 1963 and the
material date being January 1,1973 after the accounts of the
year were finalised, the directors transferred, out of the
profits of Rs. 61,03,382 of that year, a sum of Rs.
29,77,000 to the general reserve. With such a transfer the
general reserve of the assessee company as on January 1,
1973, stood at Rs. 36,07,712 at the end of the calendar year
1972. In the annual general meeting held on June 30, 1973,
dividend of Rs. 3,10,450 was declared by the shareholders
and the same was soon thereafter paid out of the said
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general reserve. In the Sur-tax assessment proceeding under
the 1964 Act the assessee claimed that the entire general
reserve which stood at Rs. 86,07,712 as on January 1, 1973
should be taken into account while computing the capital of
the assessee company. It was negatived by the taxing
officer who deducted Rs. 3,10,450 from the general reserve
and the balance was added to the capital. The Appellate
Commissioner and the Income-tax Appellate Tribunal confirmed
the order. On reference, the High Court upheld the order
which was approved by this Court.
Thus we have no hesitation to hold that though the
general body of the shareholders resolved and appropriated
on May 31, 1963 to the dividend of Rs. 76,00,000 from the
reserve of Rs. 90,00,000, it related back to the relevant
assessment year, and therefore as on Ist January 1963 Rs.
76,00,000 was provision and cannot be computed as capital.
Only Rs. 14,00,000 would be treated to be reserve. The
Tribunal and the High Court, therefore, correctly laid down
the law and it does not warrant interference. The appeal is
accordingly dismissed but in the circumstances parties are
directed to bear their own costs.
Y. Lal Appeal dismissed.
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