Full Judgment Text
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PETITIONER:
COMMISSIONER OF INCOME-TAX,BOMBAY CITY
Vs.
RESPONDENT:
THE CENTURY SPINNING AND MANUFACTURING CO. LTD.THE CENTURY
DATE OF JUDGMENT:
08/10/1953
BENCH:
HASAN, GHULAM
BENCH:
HASAN, GHULAM
SASTRI, M. PATANJALI (CJ)
DAS, SUDHI RANJAN
BOSE, VIVIAN
BHAGWATI, NATWARLAL H.
CITATION:
1953 AIR 501 1954 SCR 203
CITATOR INFO :
R 1961 SC 812 (5,11)
RF 1966 SC1393 (13,16,23)
R 1981 SC2105 (8,26,37,40,41,43,46)
ACT:
Business Profits Tax Act (XXI of 1947), Sch. II, rr. 2
and 3--Determination of capital of company-Inclusion of
‘reserves’-- Accumulated profit carried over to next year
without declaring it as reserve-Whether ’reserve’-Indian
Companies Act (VII of 1913), ss. 131-A, 132, Sch. I, Table
A, Reg. 99.
HEADNOTE:
The balance sheet of a company for the calendar year
1945 showed a profit of Rs. 90,44,677, subject to the
provision for depreciation and taxation, and, after giving
credit to these items
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the balance of Rs. 5,08,637 was carried to the balance sheet
of the next year on the 1st January, 1946, without making or
declaring it a reserve. On the 28th February, 1946, the
directors marked it for distribution as dividend, on the 3rd
April, a resolution was passed for distributing it as
dividend, and a few days, later it was actually distributed
as dividend:
Held, that as the said sum of Rs. 5,08,637 was never
earmarked or declared as a reserve, but was, on the other
hand, earmarked for distribution as dividend on the 28th
February and 3rd April and was actually so distributed, it
cannot be deemed to be a reserve and added to the paid-up
capital in determining the company’s capital under rr. 2 and
3 of Sch. II to the Business Profits Tax Act, 1947, for the
chargeable accounting period commencing on the 1st April,
1946.
Held also, that the profits of the company from the 1st
January to 1st April, 1946, cannot also be treated as
reserves.
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JUDGMENT:
CIVIL APPELLATE JURISDICTION -. Civil Appeals Nos. 157 and
158 of 1952.
Appeals from the Judgment and Order dated the 29th day
of March, 1951, of the High Court of Judicature at Bombay
(Chagla C.J. and Tendolkar J.) in its Original Civil
Jurisdiction in Income-tax Reference No. 27 of 1950.
G.N. Joshi for the Commissioner of Income-tax.
R.J. Kolah for the Century Spinning and Manufacturing Co.
Ltd.
1953. October 8. The Judgment of the Court was delivered by
GHULAM HASAN J. These two connected appeals, one by the
Commissioner of Income-tax, Bombay, and the other by the
Century Spinning & Manufacturing Co. Ltd., arise out of the
judgment and order of the Bombay High Court delivered on a
reference made by the Income-tax Appellate Tribunal, Bombay.
The two questions of law referred by the Tribunal were
as follows:-
(1) Whether the amount of Rs. 5,08,637 is a part of the
reserves’ of the assessee company as on 1st April, 1946,
within the meaning of rule 2(1) of the rules in Schedule II
to the Business Profits, Tax Act, and
205
(2) Whether the profits of them assessee company from 1st
January to 1st April, 1946, should be included in the said
reserves as on 1st April, 1946.
The High Court answered the first question in the
affirmative and the second in the negative.
The accounting year followed by the assessee is the calendar
year and the chargeable accounting period is the 1st of
April, 1946, to the 31st of December, 1946, in respect of
the profits ending with 31st December, 1945. The profits
according to the profit and loss account were Rs. 90,44,677
subject to the provisions for depreciation and taxation.
After making provisions for these, the balance of Rs.
5,08,637 was carried to the balance-sheet.
Two contentions were raised on behalf of the assessee before
the Income-tax Officer, the first being whether the
aforesaid sum could be called a "reserve" within the meaning
of rule 2(1) of the Rules in Schedule II to the Business
Profits Tax Act and whether it should be included in its
reserves while determining the capital on the 1st April,
1946; the second that the proportionate profits of the
assessee for three months, between the 1st January, 1946,
and the 1st April, 1946, should also be included in the said
reserves. The Income-tax Officer rejected the contention
holding that "A ’reserve’ represents profits set apart for
some specific or general purpose and therefore profits which
have not been so set apart cannot be treated as forming part
of reserves for the purpose of inclusion in the capital."
This order was confirmed on appeal by the Appellate
Assistant Commissioner but was set aside by the Income-tax
Appellate Tribunal. Thereupon the Tribunal formulated the
two questions aforementioned for reference to the High Court
under section 66(1) of the Act, read with section 19 of the
Business Profits Tax Act of 1947. As already stated the
High Court decided the first question in favour of the
assessee and the second in favour of the department. Hence
the two appeals.
The Business Profits Tax Act (No. XXI of 1947) came into
force on the 11th April, 1947, having taken
28
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the place of the Excess Profits Tax Act which was repealed
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on the 30th March, 1946. This Act, as is we] I known, was
designed to assess large profits made by companies carrying
on business during the boom years of the war. It was
revived, as it were, after a year in the shape of the
present Act, though in a modified form. Section 4 Which is
the charging section, so far as it is material for our
purposes, permits the levying on the amount of the "taxable
profits" during any "chargeable accounting period", a tax
called the "business profits tax" which shall be equal to
sixteen and two-thirds per cent of the taxable profits.
"Taxable profits" means the amount by which the profits
during a chargeable accounting period exceed the abatement
in respect of that period [section 2(17)]. "Abatement",
according to section 2 (1) means, in respect of any
chargeable accounting period ending on or before the 31st
day of March, 1947, a sum which bears to a sum equal to-
"(a) in the case of a company, not being a company
deemed for the purposes of section 9 to be a firm, six per
cent. of the capital of the company on the first day of the
said period computed in accordance with Schedule II, or one
lakh of rupees, whichever is greater.........the same
proportion as the said period bears to the period of one
year .........."
"Accounting period" according to section 2(2) in relation
to any business means any period which is or has been
determined as the previous year for that business for the
purposes of the Indian Income-tax Act, 1922. Lastly
"chargeable accounting period" is defined in section 2(4) as
follows:-
"(a) any accounting period falling wholly within the
terms beginning on the first day of April, 1946, and ending
on the thirty-first day of March ;
(b) where any accounting period falls partly within and
partly without the said term, such part of that accounting
period as falls within the said term:".
It appears that the definition of abatement contemplates
that the normal profit of a company is six per cent, on its
capital and where the, profit exceeds
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that amount, it becomes liable to pay business profits tax.
Schedule 11 lays down the rule for computing the capital of
a company for purposes of business profits tax and rule 2(1)
of the Schedule which admittedly applies to the present case
lays down that "Where the company is one to which rule 3 of
Schedule I applies, its capital shall be the sum of the
amounts of its paid-up share capital and of its reserves in
so far as they have not been allowed in computing the
profits of the company for the purposes of the Indian
Income-tax Act.........."
The point that arises for consideration on the first
question is whether the assessee is entitled to treat the
sum of Rs. 5,08,637 as a reserve and to add it to its paid-
up share capital for the purposes of computing the
abatement. Two essential characteristics must be present
before the assessee can avail himself of the benefit of the
rule, namely, that the amount should not have been allowed
in computing the profits of the company for the purposes of
Income-tax Act and that it should be a reserve as con-
templated by the rule. That it has not been so allowed is
not denied and therefore the only question is whether it can
be treated as a reserve within the meaning of the rule. The
balance-sheet shows that the company made a profit of Rs.
90,44,677 for the calendar year 1945 subject to the
provision of depreciation and taxation. After giving credit
for these items the balance of Rs. 5,08,637 was carried to
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the balance-sheet on 1st January, 1946, in the profit and
loss account. On the 28th February, 1946, the directors
recommended that the aforesaid sum should be appropriated in
the following manner: --
Payment of a final dividend at the rate of Rs. 18 per
share (making Rs. 28 per share for the whole year) free of
income-tax absorbing... Rs. 4,92,426-0-0 Balance to be
carried forward to
next year’s account ... Rs. 16,211-6-8
This recommendation was accepted by the shareholders in
their meeting on the 3rd April, 1946, by a resolution passed
to that effect. The dividend was made payable on the 15th
April, 1946, and it is not
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denied that it was actually distributed. These being the
facts, the question arises whether the amount in question
can be called a "reserve".
The term "reserve" is not defined in the Act and we must
resort to the ordinary natural meaning as understood in
common parlance. The dictionary meaning of the word
"Reserve" is :-
" 1(a) To keep for future use or enjoyment; to store up
for some time or occasion; to refrain from using or enjoying
at once.
(b) To keep back or hold over to a later time or place
or other further treatment.
6. To set apart for some purpose or with some end
in view; to keep for some use.
11.To retain or preserve for certain purposes."
(Oxford Dictionary, Vol. VIII, p. 513).
In Webster’s New International Dictionary, Second Edition,
page 2118, "Reserve" is defined as follows:
"1. To keep in store for future or special use; to keep in
reserve; to retain, to keep, as for oneself.
2.To keep back; to retain or hold over to a future
time or place.
3. To preserve."
What is the true nature and character of the disputed
sum, must be determined with reference to the substance of
the matter and when this is borne in mind, it follows that
on the 1st of April, 1946, which is the crucial date, the
sum of Rs. 5,08,637 could not be called a "reserve", for
nobody possessed of the requisite authority had indicated on
that date the manner of its disposal or destination. On the
other hand, on the 28th February, 1946, the directors
clearly ear-marked it for distribution as dividend and did
not choose to make it a reserve. Nor did the company in its
meeting on the 3rd April, 1946, decide that it was a
reserve. It remained on the 1st of April as a mass of
undistributed profits which were available for distribution
and not ear-marked as "reserve". On the 1st of January,
1946, the amount was simply brought from
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the profit and loss account to the next year and nobody with
any authority on that date made or declared a reserve. The
reserve may be a general reserve or a specific reserve, but
there must be a clear indication to show whether it was a
reserve either of the one or the other kind. The fact that
it constituted a mass of undistributed profits on the 1st
January, 1946, cannot automatically make it a reserve. On
the 1st April, 1946, which is the commencement of the
chargeable accounting period, there was merely a
recommendation, by the directors that the amount in question
should be distributed as dividend. Far from showing that
the directors had made the amount in question a reserve, it
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shows that they had decided to ear-mark it for distribution
as dividend. By the resolution of the shareholders on the
3rd April, 1946, the amount was shortly afterwards
distributed as dividend. The High Court appear to have been
under a misapprehension as to the real position, for they
observed :-"It was open to the directors to distribute the
sum of Rs. 5,08,537 as dividends. They did not choose to do
so and have kept back this amount. Therefore, by keeping
back this amount they constituted it a reserve. A reserve
in the sense in which it is used in rule 2 can only mean
profit earned by a company and not distributed as dividend
to the shareholders but kept back by the directors for any
purpose to which it may be put in future. Therefore, giving
to the ’reserves’ its plain natural meaning, it is clear
that the sum of Rs. 5,08,637 was kept in reserve by the
company and not distributed as profits and subjected to
taxation. Therefore, it satisfied all the requirements of
rule 2." The directors had no power to distribute the sum as
dividend. They could only recommend, as indeed they did,
and it was up to the shareholders of the company to accept
that recommendation in which case alone the distribution
could take place. The recommendation was accepted and the
dividend was actually distributed. It is, therefore, not
correct to say that the amount was kept back. The nature of
the amount which was nothing more than the undistributed
profits of the company, remained unaltered. Thus the
profits lying unutilized and not
210
specially set a part for any purpose on the crucial date
did not constitute reserves within the meaning of’ Schedule
II, rule 2 (1).
Reference was made to sections 131 (a) and 132 of the
Indian Companies Act. Section 131 (a) enjoins upon the
directors to attach to every balance-sheet a report with
respect to the state of company’s affairs and the amount if
any which they recommend to be paid by way of dividend and
the amount, if any, which they propose to carry to the
Reserve Fund, General Reserve or Reserve Account. The
latter section refers to the contents of the balance-sheet
which is to be drawn up in the Form marked F in Schedule
III. This Form contains a separate head of reserves.
Regulation 99 of the First Schedule, Table A, lays down
"that the directors may, before recommending any dividend
set aside out of the profits of the company such sum as they
think proper as a reserve or reserves which shall, at the
discretion of the directors, be applicable for meeting
contingencies, or for equalising dividends, or for any other
purpose to which the profits of the company may be properly
applied......... The Regulation suggests that any sum out of
the profits of the company which is to be made as a reserve
or reserves must be set aside before the directors recommend
any dividend. In this case the directors while recommending
dividend took no action to set aside any portion of this sum
as a reserve or reserves. Indeed they never applied their
mind to this aspect of the matter. The balance-sheet drawn
up by the assessee as showing the profits was prepared in
accordance with the provisions of the Indian Companies Act.
These provisions also support the conclusion as to what is
the true nature of a reserve shown in a balance-sheet.
We are, of the opinion that the view taken’ by the Bombay
High Court is erroneous and must be set aside. The appeal
of the Commissioner of Income-tax is allowed with costs.
As regards the second question, Mr. Kolah the learned
counsel for the company, frankly conceded that the view
taken by the High Court on this part of the case is not open
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to challenge and is correct. The
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High Court held that the profits for three months from the
1st January, 1946, to the 1st April, 1946, were not reserves
which would attract the application of rule 2 of Schedule
11. With this conclusion we agree. The assessee’s appeal
is, therefore, dismissed with costs.
Appeal No. 157 allowed.
Appeal No. 158 dismissed.
Agent for the Commissioner of Income-tax: G. H.
Rajadhyaksha.
Agent for the company: I. N. Shroff.