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CASE NO.: Appeal (civil)  2741 of 2007

PETITIONER: Commissioner of Income Tax, New Delhi

RESPONDENT: Oriental Fire & General Insurance Co. Ltd

DATE OF JUDGMENT: 18/05/2007

BENCH: S.B. Sinha & Markandey Katju

JUDGMENT: J U D G M E N T

CIVIL APPEAL NO.       2741                 OF 2007  [Arising out of S.L.P. (Civil) Nos. 1008-1010 of 2005] W I T H  CIVIL APPEAL NOS. 2742, 2743, 2744, 2745 OF 2007 [Arising out of S.L.P. (Civil) Nos.2037 of 2005, 5350, 5351 and 10820 of 2006]  

S.B. SINHA, J  :

1.      Leave granted in all the Special Leave Petitions.   

2.      Respondent is a subsidiary to the General Insurance Corporation of  India.  It is wholly a government owned company engaged in the business of  general insurance.  It is an income-tax asessee.  Its affairs, indisputably, are  governed by the provisions of the Insurance Act, 1938 (for short, ’the 1938  Act).  For the assessment years 1974-75, 1975-76 and 1978-79, it filed its  income tax  returns.  Such returns were filed relying on or on the basis of   the annual accounts furnished by it before the Controller of Insurance.          3.      The Assessing Officer  opined that Respondent was not entitled to any  deduction in respect of the  provisions of taxation by way of "reserve for bad  and doubtful debts" and "entertainment allowance". The Commissioner  (Appeals), however, in respect of the assessment year 1974-75 allowed  various deductions and the order of the Assessing Officer disallowing  certain expenditure was set aside by orders dated 09.02.1979 and  09.09.1980.   

4.      Both the orders were questioned by the  Revenue before the Income  Tax Appellate Tribunal (for short, ’the Tribunal).  By reason of an order  dated 30.11.1981, the Tribunal held that the Assessing Officer was not  correct in refusing to accede to the deductions under the aforementioned  heads claimed by the assessee.   

5.      The following questions of law were referred to the High Court  under  Section 256 of the Income Tax Act, 1961 (for short, ’the 1961 Act’).

"1.     Whether on the facts and in the circumstances of  the case, and on a true interpretation of section 44 of the  Income Tax, 1961 read with Rule 5 of the First Schedule  to the said Act, the Tribunal was right in confirming the  addition of the following amounts to the Balance of  profits disclosed by the annual accounts of the assessee  Insurance Company

i)      Tax deducted at source :                Rs.76,74,713/- ii)     Provision for taxation :                Rs.6,57,00,000/-

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Total                                           Rs.7,33,74,713/-

(This question is referred at the instance of the assessee  for the assessment year 1974-75)

2.      Whether on the facts and in the circumstances of  the case, the Tribunal was correct in law in holding that  reserve for bad and doubtful debts cannot be added to the  Balance of profit disclosed in the annual accounts of the  assessee insurance company ?

(This question is referred at the instance of Revenue for  the assessment year 1974-75)"

6.      The High Court, however, by reason of the impugned judgment  answered the said reference in favour of the respondent and against the  Revenue.  Indisputably, the question as to whether the respondent was  entitled to deductions under the head "Entertainment Allowance" is not in  question before us.

7.      Mr. Mohan Parasaran, the learned Additional Solicitor General  appearing on behalf of the Revenue, would submit that the terms ’provision’  and ’reserve’ connote two different meanings, and, thus, there cannot be any  provision for "bad and doubtful debts" and in that view of the matter, the  High Court committed a serious error in passing the impugned judgment.       

8.      The Assessing Authority, the learned counsel would point out, has  assigned sufficient and cogent reason for arriving at its decision.  It was  furthermore argued that the provisions for tax cannot be claimed to be an  expenditure and in that view of the matter the Assessing Officer in regard to  the concept of provision for tax was entitled to invoke its jurisdiction in  arriving at a finding as to whether the assessee was entitled to the deductions  claimed by it or not.

9.      Mr.  M.S. Syali, the learned Senior Counsel appearing on behalf of the  assessee, on the other hand, would support the impugned judgment.   

10.     Determination of liability of income tax under the provisions of the  1961 Act for the purpose of computation of income of an assessee, inter  alia, for carrying on business in insurance is governed by Section 44 thereof  and Rule 5(a) of the First Schedule appended thereto, which read as under :

"S.44.-Notwithstanding anything to the contrary  contained in the provisions of this Act relating to the  computation of income chargeable under the head  "Interest on securities", "Income from house property,  capital gains or Income from other sources, or in sections  28 to 43 A, the profits  and gains of any business of  insurance, including any such business carried on by a  mutual insurance company or by a cooperative society,  shall be computed in accordance with the rules contained  in the First Schedule."

"Rule 5(a).- 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, copies of which are required under the  Insurance Act, 1938 (4 of 1938) to be furnished to the  Controller of Insurance, subject to the following  adjustments :

(a)     Subject  to  the  other provisions of this rule, any          expenditure or allowance which is not admissible

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       under the provisions of Sections 30 to 43A in          computing the profits and gains of a business shall          be added back."

11.     Section 44 contains a non obstante clause.  It provides for a special  mode in which the assessee carrying on business, inter alia, in general  insurance should be assessed.   

12.     The reason for it is not far to seek as the matter relating to "carrying  on business"  in General Insurance is covered by the 1938 Act.  By reason of  Section 11 of the 1938 Act every insurer is required to prepare : (a) Balance  Sheet; (b) Profit and Loss Account ; and  (c) a revenue account;  at the  expiry of each calendar year wherefor special forms are prescribed.  Their  Balance Sheets and Profit and Loss Accounts etc. are audited by the  auditors.  Prudential regulation in the context of insurance business has  seminal importance as it caters to its very nature, which entails pooling of  risk.  Acturial oversight involves keeping a tab on ’financial condition’ of  companies, valuation of liabilities, inter alia, with regard to which       investigation is required to be made at intervals of not less two years from  the date they are submitted before the Controller of Insurance.  The said  authority has a wide jurisdiction.  It may take evidence and order revaluation  as also investigate into the affairs of the insurance company.  The statute  provides for checks and balances.  It mandates as to the kind of investments  which the insurer must make.  The provisions of the 1938 Act and the  regulations framed thereunder provide for the details in which the accounts  are to be maintained.   

13.     Insurance companies in view of the provisions of the said Act,  however, are dealt with also under the 1961 Act differently.  Section 44  thereof, as noticed hereinbefore, begins with a non-obstante clause.  The  jurisdiction of the Income Tax Officer in passing the orders of assessment is  limited.  Keeping in view the fact that the business carried out by the  assessee is not governed by the ordinary principles applicable to business  computation as laid down in Section 10 of the 1961 Act, the insurance  companies do not compute their profits annually in the manner laid down  therein.

14.     A bare perusal of Rule 5(a) of the 1961 Act  would categorically  demonstrate that ordinarily the annual accounts furnished before the  Controller of Insurance would be taken to be the balance of the profits  disclosed thereby.  The same, however, is subject to the adjustments  mentioned therein, namely, any expenditure or allowance which is not  admissible under the provisions of Sections 30 to 43A in computing the  profits and gains of the business.  If the said provision is found to be  applicable, the amount may be added back.

15.     The rules lay down as to how the Income Tax Officer must proceed in  the matter if he finds any inaccuracy in the said accounts.            16.     The question came up for consideration before this Court in relation to  business of life insurance in Life Insurance Corporation of India. v.  Commissioner of Income Tax, Delhi & Rajasthan [1964 (5) SCR 880].   Therein,  this Court had the occasion to consider the relevant provisions of  the 1938 Act as also the 1961 Act.  In respect of  business of insurance other  than life insurance,  a matter  fell for consideration in Pandhyan Insurance  Co. Ltd. v. Commissioner of Income-Tax, Madras  [1965 (1) SCR 367],  wherein  it was categorically held that the rules do not empower the Income  Tax Officer to adjust the accounts on the basis of revaluation made by him  or to correct the discrepancy between what is entered into the accounts and  what is fact.

17.     In Commissioner of Income-Tax, West Bengal, Calcutta v. Calcutta  Hospital and Nursing Home Benefits Association [1965 (3) SCR 632]  application of  Rule 6  to the Schedule appended to the Income Tax Act  came up for consideration of this Court, wherein the law was laid down in

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the following terms :                  "11. The Section adopted the device of a deeming  provision. The profits arising from the transactions of a  company or society with its members were deemed to be  profits arising from transactions with non-members  Parliament assumed that the latter were taxable. As this  hypothesis was wrong Parliament failed in its objective.  But the Indian Legislature did not adopt any deeming  device. It defined income to include profits of any  business of insurance carried on by a mutual insurance  association. What are those profits is then explained by  reference to the Schedule. The effect of this in substance  is to incorporate Rule 6 into the definition. If the  legislature had defined income to include profits of  insurance earned on by a mutual insurance association  computed according to Rule 6, very little would have  remained arguable."

18.     There cannot be any doubt whatsoever, as was submitted by the  learned Additional Solicitor General, that there exists a distinction between   a  ’provision’ and ’reserve’.  It was so held in Vazir Sultan Tobacco Co.  Ltd., Hyderabad etc. v. Commissioner of Income Tax, Andhra Pradesh,  Hyderabad etc.  [(1981) 4 SCC 435] in the following terms :         "9. The distinction between the two concepts of  reserve and provision is fairly well known in commercial  accountancy and the same has been explained by this  Court in Metal Box Company of India Ltd. v. Workmen  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 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  proprietors interest. (See Spicer and Pegler: Book- keeping and Accounts, 15th Edn., p. 42.) In other words the broad distinction between the two is that  whereas a provision is a charge against the profits to be  taken into account against gross receipts in the Profit and  Loss Account , a reserve is an appropriation of profits, the  asset or assets by which it is represented being retained to  form part of the capital employed in the business. Bearing  in mind the aforesaid broad distinction we will briefly  indicate how the two concepts are defined and dealt with  by Companies Act, 1956."

19.     Our attention, in this behalf, has also been drawn by the learned  Additional Solicitor General to State Bank of Patiala, Patiala v.  Commissioner of Income Tax, Patiala [(1996) 3) SCC 513], wherein  Paripoornan, J. speaking for a Division Bench noticed :         "12. A fair reading of the above decisions would  go to show that if the transfer of amount is made ad hoc,  when there is no known or anticipated liability, such fund  will only be treated as reserve. In this case, substantial  amounts were set apart as reserves. No amount of bad  debts was actually written off or adjusted against the  amount claimed as reserves. No claim for any deduction

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by way of bad debts were made during the relevant  assessment years. The assessee never appropriated any  amount against any bad and doubtful debts. The amounts  throughout remained in the account of the assessee by  way of capital and the assessee treated the said amounts  as reserves and not as provisions designed to meet  liability, contingency, commitment or diminution in the  value of assets known to exist at the relevant dates of  Balance-sheets. These facts have been found by the  Tribunal. On the facts, the amount set apart as reserves  cannot be said to be so earmarked, when any liability has  actually arisen or was anticipated by the assessee. It  cannot be said either, that the amounts set apart out of the  profits were designed to meet any known liability, that  existed at the date of the Balance-sheet. Tested in the  light of the decisions of this Court, referred to  hereinabove, it appears to us, that the amounts set apart  towards bad and doubtful debts in these cases are  reserves qualifying for appropriate relief under Rule  1(xi)(b) of the First Schedule and Rule 1(iii) of the  Second Schedule of the Act."

20.     The said decision was rendered in a case involving the Companies  (Profits) Surtax Act, 1964.  It was decided on the fact situation obtaining in  that case.   

21.     Section 36(1)(vii) of the Act lays down the following conditions for  allowance of a claim for a bad debt  :

       i)      It must be a proper debt, or a part thereof;         ii)     It must be of a revenue nature as contra distinguished from that                         of  capital nature;               (a)     It has been taken into account in computing the          income of the assessment of that previous year or of an          earlier previous year, or                 (b)     represents   money  lent  in   the   ordinary   course  of the                          business of banking.         iii)    which is established to have become a bad debt in the previous                   year; and          iv)     has   been  written  off   as   irrecoverable  in the accounts of the                  assessee for the previous year.

22.     We are, however, of the opinion that it is not necessary for us to dwell  further upon the said question, inasmuch as a distinction between a  ’provision’ and ’reserve’ had been kept in mind by the authorities under the  1961 Act as also the High Court.  Every provision, however, needs not be an  expenditure, as the same may represent  a liability.   

23.     While calculating the profit and loss, what is primarily necessary to be  taken into account is the gross profit.  The amount of income tax payable for  the said purpose would not come within the purview of the definition of the  term ’expenditure’.  It was so held in Ashton Gas Company v. Attorney  General and Others [(1906) AC 10] in the following terms :                          "My Lords, so presented,  the case appears to me  to be perfectly clear.  The fallacy has been in arguing as  if you can deduct from the income tax which you have  got to pay something which alters what is the real nature  of the profit.  Now the profit upon which the income tax  is charged is what is left after you have paid all the  necessary expenses to earn that profit.  Profit is a plain  English word; that is 2what is charged with income tax.   But if you confound what is the necessary expenditure to  earn that profit with the income tax, which is a part of the  profit itself, one can understand how you get into the

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confusion which has induced the learned counsel at such  very considerable length to point out that this is not a  charge upon the profits at all.  The answer is that it is.   the income tax is a charge upon the profits; the thing  which is taxed is the profit that is made, and you must  ascertain what is the profit that is made before you  deduct the tax \026 you have no right to deduct the income  tax before you ascertain what the profit is. I cannot  understand how you can made the income tax part of the  expenditure\005"         

24.     Yet again in Allen (H.M. Inspector of Taxes) v. Farquharson Brothers  and Company [XVII Tax Cases  54],  it was held :

       "Now it is not  necessary for me to discuss, and I  do not need to discuss, in detail or, indeed, at all,  although my attention was properly called to it by  counsel, the exact nature of the Income Tax and its  distinction from Excess Profits Duty.  The distinction, of  course, is perfectly familiar and, in a general way, is  recollected by anybody who has ever had anything to do  with these things.  Income Tax is not a deduction before  you arrive at the profits; it is a part of the profits.  It is, as  has been expressed by some well-known person \026 I  cannot remember who, but it does not matter \026 the  Crown’s share of the profits.  Excess Profits Duty was  quite a different sort of thing.  That was a deduction, the  sum to be deducted before you arrived at the profits for  the purpose of computation, with the result that you  deducted the Excess Profits Duty in arriving at the  computation and then if, as sometimes happened, later  on, some Excess Profits Duty was got back, that Excess  Profits Duty had to be brought in\005."

        25.     The said principle has been applied  by this Court in Bharat  Commerce & Industries Ltd. v. Commissioner of Income Tax, Central-II  [(1998) 3 SCC 510], stating  :         "6. The expenses in that case were incurred for a  very different purpose from the purpose for which the  assessee has paid interest in the present case. When  interest is paid for committing a default in respect of a  statutory liability to pay advance tax, the amount paid  and the expenditure incurred in that connection is in no  way connected with preserving or promoting the business  of the assessee. This is not expenditure which is incurred  and which has to be taken into account before the profits  of the business are calculated. The liability in the case of  payment of income tax and interest for delayed payment  of income tax or advance tax arises on the computation  of the profits and gains of business. The tax which is  payable is on the assessees income after the income is  determined. This cannot, therefore, be considered as an  expenditure for the purpose of earning any income or  profits. The ratio of Birla Cotton Mills case is not  applicable in the present case."

26.     It is, therefore, evident that the provision of income tax being not an  expenditure, the Assessing Officer could not have exercised its jurisdiction  in relation thereto.

27.     Reliance has been placed by the learned Additional Solicitor General  on Madras Motor & General Insurance Co. Ltd. v. Commissioner of Income  Tax, Madras [1979 (117) ITR 534].  In the said decision also, the Madras

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High Court categorically held that the provision for payment of income-tax  is a liability and not an expenditure.  The question again came up for  consideration recently in General Insurance Corporation of India v.  Commissioner of Income Tax, Bombay [(1999) 8 SCC 60] wherein this  Court rejected the contention of the learned counsel for the assessee therein,  in the fact situation obtaining in that case,  opining :         "19. There is another approach to the same issue.  Section 44 of the Income Tax Act read with the rules  contained in the First Schedule to the Act lays down an  artificial mode of computing the profits and gains of  insurance business. For the purpose of income tax, the  figures in the accounts of the assessee drawn up in  accordance with the provisions of the First Schedule to  the Income Tax Act and satisfying the requirements of  the Insurance Act are binding on the assessing officer  under the Income Tax Act and he has no general power  to correct the errors in the accounts of an insurance  business and undo the entries made therein."   28.     Section 40(a)(ii) of the 1961 Act, it will bear repetition to state,  provides for a non-obstante clause.  It is of wide magnitude.  Sections 32 to  38 of the 1961 Act refer to expenditure admissible under the Act.  Section  40, however, seeks to make an exception thereto stating that some  expenditures would not be allowed.  Section 40(a)(ii), however, does not say  that the income-tax would be an expenditure.  It does not provide as to how  a total income of a person should be computed.  It provides for other types  of taxes.  The said provision has, therefore, no application in the instant case.

29.     So far as the question of ’bad and doubtful claims’ is concerned, again  the same is not an expenditure.  Section 36(1)(vii) of the Act whereupon the  learned Additional Solicitor General placed  strong reliance,  cannot be said  to have any application whatsoever in the instant case.  It is not relevant for  computing the profit under  the 1961 Act.  In any event, Section 44 of the  Act provides for a non -obstante clause and, thus, would prevail over the  former.

30.     For the reasons aforementioned, we find no merit in these appeals,  which are dismissed accordingly with costs.  Counsel’s fee is assessed at Rs.  10,000/- in each case.