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PETITIONER: COMMISSIONER OF INCOME TAX, GUJARAT

       Vs.

RESPONDENT: JYOTI LIMITED

DATE OF JUDGMENT:       15/02/1996

BENCH: MAJMUDAR S.B. (J) BENCH: MAJMUDAR S.B. (J) JEEVAN REDDY, B.P. (J)

CITATION:  JT 1996 (2)   360        1996 SCALE  (2)187

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T S.B. Majmudar,J.      These appeals  by certificate  granted on 12th December 1977 by the Gujarat High Court arise out of its judgment and order dated  21st June  1977 in Income Tax Reference No.6 of 1976. The  Commissioner  of  Income  Tax,,  Gujarat  is  the appellant while  the assessee company is the respondent. the Income  Tax   Appellate  Tribunals  Ahmedabad  referred  the fallowing question  for the  opinion of  the High  Court  of Gujarat under  Section 18  of the Companies (Profits) Surtax Act, 1964 thereinafter referred to as ’the Surtax Act’] read with Section 256(1) of the Income Tax Act. 1961 :      "Whether, on  the facts  and in the      circumstances  of   the  case,  the      Tribunal  was  correct  in  law  in      holding that  reserve for  doubtful      debts and  gratuity reserve created      by the  assessee were includible in      computing  the   capital  for   the      purpose  of   computing   statutory      deduction?" However, the  Division Bench of the High Court by consent of the parties reframed the question as under :      "Whether on  the facts  and in  the      circumstances  of   the  case,  the      Tribunal  was  correct  in  law  in      holding     that     rehabilitation      reserve, - reserve - for 1 doubtful      debts and  gratuity reserve created      by the  assessee were includible in      computing  the   capital  for   the      purpose  of   computing   statutory      deduction?" The said  reframed question was answered against the Revenue and in  favour of  the assessee  and  that  is  how  at  the instance of  the Revenue the present proceedings have arisen

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on certificate granted by the High Court.      At the  time of  final hearing  of  these  appeals  the learned counsel for the appellant Commissioner of Income Tax placed for  our consideration  only the following aspects of the question : 1. Whether  reserve for meeting doubtful debts was a reserve or a provision. Z. Whether  gratuity reserve  created by  the assessee was a reserve or a provision. So far  as the  aforesaid two  aspects of  the question  are concerned we may at the outset note a few introductory facts leading to these proceedings. Introductory Facts ------------------      The concerned assessment years are 1967-68 and 1968-69, the previous  years  being  calendar  years  1966  and  1969 respectively. The  respondent-assessee is a company which at the relevant  time was  carrying on  business at Baroda. The respondent was governed by the provisions of the Surtax Act. The respondent  claimed that  in computing  its capital base for the relevant years gratuity reserve of Rs.5,60,000/- and reserve for  doubtful debts  of Rs.85.000/-  should be taken into consideration.  The Surtax  Officer held  that the said amounts cannot be considered for computation  of capital. He accordingly exclude them from the capital computation in the assessment proceedings. Being aggrieved by the orders of the Surtax Officer  the assessee  carried the  matter in  appeal before the  Appellate Assistant  Commissioner of  Surtax, B- Range,  Baroda.   The   Appellate   Assistant   Commissioner following the decision of the Tribunal in S.T.A. Nos.7 and 8 (Ahd.) of  1971-72 decided  on 19th  August 1973 which arose out of  the assessee’s surtax assessments for the assessment years 1965-66  and 1966-67  held that the aforesaid reserves should be  considered as part of the capital while computing the capital base for calculation of statutory deduction.      Being aggrieved by the order of the Appellate Assistant Commissioner the  Revenue  preferred  appeals  being  S.T.A. Nos.6 and  7 (Ahd.) of 1973-74. The  Tribunal relying on its decision in  S.P.T.A. No.5  (Ahd.)   of 1971-72  and  S.T.A. Nos.7-10 (Ahd.)  of  1971-72  decide  on  19th  August  1973 confirmed  the   view  taken   by  the  Appellate  Assistant Commissioner. Thereafter  at the instance of the Revenue the aforesaid question  was referred to the High Court. which as stated earlier. was reframed by the High Court.      We shall  first deal  with the  question regarding  the inclusion of Rs.85,000/- sought to be treated as reserve for meeting doubtful debts in the capital base of the respondent company. So  far as  this reserve  is  concerned,  as  noted earlier. the Appellate Assistant Commissioner as well as the Tribunal relied  upon the  assessments for the earlier years for  the  very  same  respondent-company  for  holding  this reserve as  includible in  the capital  base. The High Court also followed suit. In our view no exception can be taken to the aforesaid  view of  the High Court. Reasons are obvious. As noted by the Income Tax Appellate Tribunal in the present proceedings. it  had already  taken a  similar view  by  its earlier order  dated 19th  August 1973 while considering the question  of  computation  of  capital  base  of  respondent assessee  company   itself  for   the  previous  years.  The pertinent observations  are found  at page  25 of  the Paper Book :      "So far  as  Reserve  for  Doubtful      debts is  concerned, ordinarily the      provision  for  doubtful  debts  is      created  with   reference  to   the

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    sundry  debtors   and  shown  as  a      deduction from  the sundry  debtors      in   the    balance   sheet.   Such      reserves,  which  are  specifically      created to  write off the bad debts      are  usually   in  the   nature  of      provision. In  the  instance  case.      the reserve  was created out of P &      L Account  without reference to the      outstanding sundry  debtors and was      not created  with a view of meeting      any anticipated  liability. We  are      told  that  this  amount  was  also      written off  as the General Reserve      Account in  the year  1966.  Having      regard to the facts of the case. we      agree  with  the  Appellate  Asstt,      Commissioner that  the reserve  for      doubtful  debts   was  not  in  the      nature of provision for meeting any      anticipated liability  and as  such      should   be    included   in    the      computation of the capital base for      both the years under appeal." As a  clear finding of fact was reached by the Tribunal that bad debt  reserve was  created out  of Profit & Loss Account without reference  to the outstanding sundry debtors and was not created with a view of meeting any anticipated liability it had  to be  held that the said amount which was set apart for meeting bad and doubtful debts was by way of reserve and not a  provision. In the case of Commissioner of Income-Tax. Kanpur v.  Saran Engineering  Co. Ltd. & Anr. (1986) 161 ITR 741, Sabyasachi  Mukharji. J.  (as he then was) speaking for the Division  Bench of  this Court,  while sitting with R.S. Pathak, J..  made the  following pertinent  observations  in this connection :      "Where the  liability has  actually      arisen    or    been    anticipated      legitimately by the assessee though      the quantum  of the  liability  has      not been determined. a fund to meet      such present  liability  cannot  be      treated as  a  "reserve".  A  fund,      however. created  for payment  of a      liability  which  had  not  already      arisen or  fallen due but is only a      provision with  regard to  the  sum      that might become liable to be paid      is  "other   reserves"  within  the      meaning of  rule 1  of  the  Second      Schedule and  should be  taken into      account in computing the capital of      the company  for the purpose of the      Companies  (Profits)   Surtax  Act.      1964." In connection  with the  question whether  bad and  doubtful debts reserve  created by  the assessee  in that  case was a reserve or not it was observed as under :      "Bad and Doubtful Debts Reserve was      created in  1956 through the Profit      and Loss Appropriation account. The      amount involved was Rs.5,00,000. It      was  submitted  on  behalf  of  the      assessee by  Shri Salve  that  this      was created  by transfer  from  the

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    appropriation account  and not as a      charge against profit. Furthermore,      a separate  provision was  made for      bad  and   doubtful   debts   which      provision  was   reduced  from  the      value of the assets. It was not the      Revenue’s case  that the  provision      for bad and doubtful debts provided      was   less   than   the      amount      reasonably    necessary    to    be      provided.  If  the  amount,  as  it      appears to  be, is  more  than  the      amount reasonably  necessary to  be      provided  in  respect  of  bad  and      doubtful debts, then it constituted      a "reserve".  It is  not correct to      state    that     by    the    very      nomenclature,  this   was   not   a      reserve. The  true  nature  of  the      transaction has to be examined." At page  746 of the Report applying the aforesaid principles to the  case on  hand it  was held  that in the light of the facts found  so  far  as  bad  and  doubtful  reserves  were concerned the  amounts  set  apart  must  be  treated  as  a reserve. On the facts of the present case, as noted earlier, it  could  not  be  said  that  there  was  any  ascertained liability for  which a  provision was  made by  creating the aforesaid reserve for bad ind doubtful debts. In the present case it  was also not the Revenue’s case that the amount set apart for  bad and  doubtful debts  reserve was less than or equal to  the amount  necessary to  be provided  for meeting ascertained liability. On the other hand the amount appeared to be more than what was reasonably necessary to be provided or in respect of the bad and doubtful debts as the amount of bad and doubtful debts itself was not an ascertained amount. Consequently  no  fault  can  be  found  with  the  decision rendered by  the authorities  below and  the High Court that the provision  of Rs.85,000/-  for doubtful  debts had to be treated as  reserve which  could be legitimately included in computing  the  capital  base  of  the  respondent  assessee company  so  far  as  the  relevant  assessment  years  were concerned.      That takes  us to  the consideration  of  the  question whether an  amount of  Rs.5,60,000/- set  apart  by  way  of gratuity for  meeting the  liability to  pay gratuity to its employees,  could  be  considered  to  be  a  reserve  or  a provision. So far as this question is concerned the Tribunal relying upon  its earlier  decision in  case  of  respondent assessee itself  for the earlier assessment years noted what was decided  in that earlier decision dated 19th August 1973 in paragraph 13 of that Order as under :      "13.  Keeping  in  mind  the  above      decisions. if  we recall  the facts      of the  case. it  is clear  that in      the instant  case, the  reserve for      gratuity was  created as  a reserve      and  not   by  means  of  provision      against any  ascertained liability.      It  is   not  disputed   that   the      assessee company had not determined      the   amount    credited   to   the      aforesaid  reserve   account,  with      reference    to    the    actuarial      valuation and  as such  the accrual      of liability  would not  arise.  if

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    the  actuarial  valuation  was  not      ascertained. In  Metal Box  Company      of India  Ltd. case  cited supra as      we have  stated in  detail, it  was      not disputed  that  the  amount  of      gratuity reserve was created on the      basis of  actuarial  valuation  and      the liability, which actually arose      during the relevant year was sought      to   be   adjusted   against   this      reserve. If  the  assessee  company      had made  a provision  against  the      anticipated liability  of  gratuity      with  reference  to  the  actuarial      valuation then the department would      have been correct in taking the sum      as  a  provision  and  consequently      disqualifying the  said amount  for      inclusion  in  the  computation  of      capital base.  In the instant case,      however,  the   facts   are   quite      different. The  amount standing  to      the Gratuity  Reserve for  the year      ended  31st   December,  1966   was      transferred to  the General Reserve      Account. This was merely a reserve,      which  was  kept  back  for  future      years  without   reference  to  any      ascertained  liability.   The  said      amount  in   any  case   would   be      includible in computing the profits      of the company. We, therefore, hold      that on  the facts of the case. the      contention   canvassed    by    the      assessee that  the impugned  amount      be  treated   as  a   reserve   for      inclusion in  the capital  base has      to  be   accepted.  We,  therefore,      accordingly direct  the Income  tax      Officer to  include  the  aforesaid      amount in  computation  of  capital      base of the Company." The aforesaid  view of the Tribunal has been accepted by the High Court.      Learned counsel  for the  Revenue vehemently  submitted that so  far as this aspect is concerned it was assumed that merely because  the assessee  company had not thought it fit to resort  to any  actuarial valuation  and had  styled  the amount as  forming part  of a reserve.  almost automatically the Surtax Officer had to treat the said amount as set apart by way  of a   reserve  and not a provision. That this would amount to giving complete latitude to the concerned assessee company. If  the assessee-company  resorts to  any actuarial valuation of  liability to  pay gratuity  to its   employees then it  would be  a provision  but if the  assessee company does not  choose to  do so.  by its  very inaction, it could insist that the provision made for discharging the liability to pay gratuity should be treated as a reserve. That such an absolute discretion  given to  the assessee would denude the Surtax Officer  of his  statutory power  and  obligation  to compute the correct capital base of the assessee-company for the  purpose  of  assessing  the  surtax  liability  of  the concerned  company.   We  find  considerable  force  in  the aforesaid contention of the learned counsel for the Revenue.      In the case of Metal Box Company of India Ltd. v. Their

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Workmen   (1963) 73  ITR 53  a Division  Bench of this Court consisting  of  J.M.  Shelat  and  C.A.  Vaidialingam,  JJ., speaking  through   Shelat.  J.   posed  two  questions  for consideration :      "(1) Whether  it is  legitimate  in      such  a   scheme  of   gratuity  to      estimate  the   liability   on   an      actuarial valuation and deduct such      estimated liability  in the  P &  L      account while  working out  its net      profits?      (2)  if   it   is,   whether   such      appropriation amounts  to a reserve      or a provision?" Considering these  two  questions  the  following  pertinent observations were made at pages 67 and 68 of the Report:      "...  In  our  view,  an  estimated      liability  under  gratuity  schemes      such as the ones before us, even if      it   amounts    to   a   contingent      liability and  is not  a debt under      the  Wealth-tax  Act,  if  properly      ascertainable and its present value      is fairly  discounted is deductible      from  the   gross  receipts   while      preparing the  P. &  L. account. It      is recognized  in  trading  circles      and we find no rule or direction in      the Bonus  Act which prohibits such      a practice.           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   (see      Spicer  and  Pegler’s  Book-keeping      and   Accounts. 15th addition, 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 provide for any

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    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)." The aforesaid  decision was  relied upon  by a  three member Bench of  this Court  consisting of  V.D. Tulzapurkar,  E.S. Venkataramiah and  Amarendra Nath  Sen, JJ..  in the case of Vazir Sultan  Tobacco Co.  Ltd. etc. etc. v. Commissioner of Income-Tax, A.P. etc. etc.  (1981) 132 ITR 559. In that case this Court  was concerned  with a  similar question which is posed for  our consideration  in  the  present  proceedings. Amongst other  questions one  of the question which fell for consideration in  that case  was whether  a gratuity reserve created by  the company  was a  reserve in the true sense of the term  or was  merely a  provision  which  could  not  be included in  the capital  base of  the assessee-company  for computing its surtax liability under the Surtax Act. In this connection  Talzapurkar.   J..  speaking   for  himself  and Venkataramiah, J. made the following pertinent observations:      "The expression  "reserve" has  not      been defined  in the  Super Profits      Tax Act,  1963. or  the C.(P.) S.T.      Act, 1964.  The dictionaries do not      make any  distinction  between  the      two    concepts    "reserve"    and      "provision"  while   giving   their      primary meanings,  whereas  in  the      context  of   those  Acts  a  clear      distinction  between   the  two  is      implied.  Though   the   expression      "reserve" is  not defined. since it      occurs    in     taxing    statutes      applicable to companies only and to      no other  assessable entities.  the      expression has  to be understood in      its popular  sense. that is to say,      the  sense   or  meaning   that  is      attributed  to   it   by   men   of      business. trade and commerce and by      persons interested  in  or  dealing      with  companies.   Therefore.   the      meanings  attached   to  the  words      "reserves" and  "provisions" in the      Companies Act.  1956, dealing  with      the  preparation  of  the  balance-      sheet  and   the  profit  and  loss      account    would    govern    their      construction for  the  purposes  of      the  two   enactments.  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." It was further observed as under :

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    "Ordinarily,  an  appropriation  to      gratuity reserve  will have  to  be      regarded as  a provision made for a      contingent liability,  for under  a      scheme  framed   by  company,   the      liability to  pay gratuity  to  its      employees   on   determination   of      employment  arises  only  when  the      employment  of   the  employee   is      determined  by  death.  incapacity,      retirement or  resignation an event      (cessation of  employment)  certain      to happen  in the service career of      every   employee;   moreover,   the      amount  of   gratuity  payable   is      usually dependent on the, employees      wages at  the time of determination      of his employment and the number of      years of  service put in by him and      the liability  accrues and enhances      with the  completion of  every year      of service but the company tan work      out on  an actuarial  valuation its      estimated     liability      (i.e.,      discounted  present  value  of  the      liability under  the scheme,  on  a      scientific  basis)   and   make   a      provision for  such  liability  not      all  at  once  but  spread  over  a      number of  years, It  is clear that      if  by   adopting  such  scientific      method any  appropriation  is  made      such appropriation  will constitute      a  provision   representing  fairly      accurately  a  known  and  existing      liability for the year in question:      if  however,   an  ad  hoc  sum  is      appropriated without  resorting  to      any    scientific     basis    such      appropriation  would   also  be   a      provision intended  to meet a known      liability. though a contingent one,      for,  the   expression  "liability"      occurring in cl.7(1)(a) of Part III      of  the   Sixth  Schedule   to  the      Companies    Act    includes    any      expenditure  contracted   for   and      arising    under    a    contingent      liability:  but   if  the   sum  so      appropriated  is  shown  to  be  in      excess of  the sum required to meet      the estimated liability (discounted      present  value  on  a    scientific      basis) it  is only  the excess that      will  have  to  be  regarded  as  a      reserve under cl.7(2) of Pt. IIl of      Sch.   VI  to  the  Companies  Act,      1956." For the aforesaid observations strong reliance was placed by the Court  on the  earlier judgment  of this  Court in Metal Box Company’s  case (supra). Applying  this principle to the facts of the case before the Court, Tulzapurkar, J., at page 574 of the Report laid  down as under :      "... the  assessee-company did  not      clarify  by   placing  material  on

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    record   as    to    whether    the      appropriation  of  the  amount  was      based on any actuarial valuation or      whether it  was an appropriation of      an ad   hoc  amount,  -  an  aspect      which, as we  shall presently point      out, has  a vital   bearing  on the      question whether  the appropriation      could be  treated as a provision or      a  reserve.  In  the  absence    of      proper material touching this vital      aspect, we are afraid, the issue in      question will  have to  be remanded      to the   taking authorities through      the Tribunal  for disposal  in  the      light   of    the   well    settled      principles in  that  behalf,  which      we shall presently indicate." On the  basis of  the aforesaid  state of  record before the Court the  following  directions  in  Vizir  Sultan  Tobacco Co.’s case (supra) were given at page 578 of the Report:      "...  Since  in  the  instant  case      sufficient  material throwing light      on  the   above  aspects   of   the      question   has    not   been   made      available, we  think, it will be in      the interest  of justice  to remand      the case  through the  Tribunal  to      the taxing  authority to decide the      issue whether  the concerned amount      (Rs.9,08,106)  set   apart      and      transferred to  gratuity reserve by      the assessee-company  was either  a      provision or  a reserve  and if the      latter to  what extent?  The taxing      authority  will decide the issue in      the light  of the  above principles      after giving an  opportunity to the      assessee    company     to    place      additional    relevant    materials      before it." In the  present case  also almost  a parallel  situation has emerged.  The  assessee-company  had  not  resorted  to  any actuarial  valuation  while  creating  gratuity  reserve  of Rs.5,60,000/-. Consequently  it was not possible to find out as to  whether the amount set apart was required to meet the discounted value  of estimated  liability or  was in  excess thereof. It  is obvious  that if there was any excess amount set apart  for the  purpose it would be treated as a reserve which could  be included in the capital base for the purpose of the  Surtax Act.  It  is  axiomatic  that  if  discounted present value  of gratuity  liability on  a scientific basis was arrived  at by  the  assessee-company  by  retorting  to actual valuation  of such  liability it  would have supplied basis for  the Surtax Officer to compute the capital base by treating the  said amount  as a provision and that if it was further found  that the  amount set  apart for  meeting such liability was  in excess  of such  provision then the excess amount could  have been  determined for  being included as a reserve in the capital base. But in the absence of assessee- company undertaking  such an  exercise, it was not as if the Surtax Officer  was helpless  or was necessarily required to accept as  gospel   truth what  the assessee  submitted  for treating the  entire amount  set apart  as  a  reserve.  The Surtax     Officer  under   such  circumstances  could  have

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legitimately   resorted to  an estimate for ascertaining the extent  of  provision  for  such  contingent  liability  for gratuity  required to be met by the assessee company- in the concerned assessment years. It would have been equally  open to the  Surtax Officer  to call upon the assessee-company to get actuarial  valuation of  such liability  to  enable  the Surtax Officer  to compute  the correct  capital base of the company in  this connection.  As no  such exercise  was done both by  the assessee  as well as by the  Surtax Officer the issue in  question will  have to  be manded  to  the  taxing authority through the Tribunal  for disposal in the light of the well  settled principles  in this  behalf  as  discussed earlier by  us. The  course adopted  by this  Court in Vazir Sultan Tobacco  Co.’s case  (supra), in  this connection, is therefore required to be adopted in the present case also.      In the  result, these  appeals are  partly allowed. The reframed question  is answered  partly in the affirmative in favour of  the assessee and against the Revenue in so far as the reserve  for doubtful  debts and  rehabilitation reserve are concerned.  However, so  far as  the answer given by the High Court  on gratuity reserve is concerned it is set aside and the  issue regarding  gratuity reserve is directed to be remanded through  the Tribunal  for re-consideration  by the Surtax Officer  for deciding  it afresh  in the light of the aforesaid principles.  after giving  an opportunity  to  the assessee-company  to  place  additional  relevant  materials before him.  As no one has appeared for the respondent there will be no order as to costs.