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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 204 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 28 206 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 207 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 208 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 209 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 211 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.