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PETITIONER: COMMISSIONER OF INCOME-TAX(CENTRAL-II), CALCUTTA

       Vs.

RESPONDENT: M/S.DUNCAN BROTHERS & CO.LTD., CALCUTTA

DATE OF JUDGMENT:       13/02/1996

BENCH: MANOHAR SUJATA V. (J) BENCH: MANOHAR SUJATA V. (J) VERMA, JAGDISH SARAN (J) BHARUCHA S.P. (J)

CITATION:  JT 1996 (2)   316        1996 SCALE  (2)132

ACT:

HEADNOTE:

JUDGMENT:                       J U D G M E N T Mrs.Sujata V.Manohar.J.      This is  an appeal  from a  decision  of  the  Calcutta High Court in a Reference made to it under Section 256(1) of the Income-tax Act, 1961.      The assessee  is a  company and  the  accounting  years involved are  the years ending on 31.12.1962 and  31.12.1963 relevant  to   the  assessment  years  1963-64  and  1964-65 respectively.      For the  assessment year  1963-64, the assessee claimed that for the purposes of Super Profits Tax Act, 1963, in the computation of its capital, a provision for taxation made by it to the tune of Rs.16,48,888/- should be treated either as a part of its capital under Rule 1 of the Second Schedule to the Super  Profits Act,  l963 or  in the  alternative  as  a deduction from  the cost  of investment under Clause (ii) of Rule 1  of the Second Schedule to the Super Profits Tax Act, 1963.      For the  assessment year  1964-65, the  assessee made a similar claim in respect of a provision for taxation made by it to  the tune  of Rs.17,52,920/-. For this assessment year the relevant provisions which were applicable were under the Companies (Profits) Surtax Act, 1964.      The claim of the assessee was disallowed by the Income- Tax  Officer.  In  appeal  before  the  Appellate  Assistant Commissioner for  the assessment year l963-64, the Appellate Assistant  Commissioner  held  that  as  the  provision  for taxation was  only an amount set apart to meet the liability for taxation  which would  accrue on  the last  day  of  the accounting year,  it could  not be  treated as a reserve and be included  in the  capital of the assessee under the Super Profits Tax Act, 1963. He, however, accepted the alternative contention of  the assessee  that the provision for taxation fell within  Clause (ii) of Rule 1 of the Second Schedule to the Super  Profits Act,  1963 and it should be deducted from

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the cost of investments in computing the capital base of the assessee-company under the Super Profits Tax, 1963.      For  the   assessment  year   1964-65,  the   Appellate Assistant Commissioner similarly held that the provision for taxation cannot  be considered as a reserve but it was to be deducted from  the cost  of investments  under Rule 2(ii) of the Second  Schedule to  the Companies (Profits) Surtax Act, 1964.      The matter  was taken  in appeal  before  the  Tribunal which came to the conclusion that the provision for taxation made in  the two  assessment years  was not  a reserve which would form  a part of the capital of the company. It further held that the provision for taxation was also neither a fund nor a surplus. It was a provision against a "perfected debt" and as  such it would not qualify for a deduction as claimed by the assessee company.       The  Tribunal made a Reference to the High Court under section 256(1)  of the Income Tax Act 1961. The questions of law which arose for determination were as follows : For the Assessment Year 1963-64      "(1) Whether,  on the  facts and in      the circumstances  of the case, the      Appellate  Tribunal  was  right  in      holding that         ‘provision for      Taxation’ is  not a  reserve as  to      form part of the capital under Rule      - 1  of the  Second Schedule to the      Super Profits Tax Act, 1963?      (2) If  the  answer  to  the  above      question  is  in  the  affirmative,      whether on  the facts  and  in  the      circumstances  of   the  case,  the      Appellate  Tribunal  was  right  in      holding that  in the computation of      capital   the   company   was   not      entitled   to    the   benefit   of      deduction   of    the   amount   of      ‘Provision for  Taxation’ from  its      cost of  investments  in  terms  of      clause (ii)  of Rule  -  1  of  the      Second  Schedule   to   the   Super      Profits Tax Act, 1963?" For the Assessment Year 1964-65      "Whether, on  the facts  and in the      circumstances  of   the  case,  the      Tribunal was  right in holding that      in the  computation of  capital the      company was  not  entitled  to  the      benefit of  deduction of ‘Provision      for  Taxation’  from  its  cost  of      investments in terms of Clause (ii)      of Rule  -2 of  the Second Schedule      of the  Companies (Profits)  Surtax      Act, 1964?"      The Calcutta  High Court has answered Question No.1 for the assessment  year 1963-64 in the affirmative in favour of the  revenue.   It  has   answered  Question  No.2  for  the assessment year  1963-64 and the question for the assessment year 1964-65  in the negative and in favour of the assessee. The revenue  has come  in appeal  before us  from the  above decision of  the Calcutta  High Court.  The assessee has not filed an  appeal before us in respect of the decision of the Calcutta High Court on Question No.1 for the assessment year 1963-64.      The only  issue before  us is whether the provision for

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taxation  can   be  deducted   from  the  cost  of  excluded investments and  would, therefore,  augment the capital base of the  company for  the purposes  of the  Super Profits Tax Act, 1963  and the  Companies (Profits)  Surtax  Act,  1964. Under both  the Acts,  the tax  is levied  on the chargeable profits of  the company  as exceed the standard deduction or the statutory deduction. Such deduction has to be worked out at the prescribed percentage of the capital of the assessee company. The  computation of  capital for  the  purposes  of these two  Acts has  to  be  made  in  accordance  with  the provisions of  the Second  Schedule in  both these Acts. The Second Schedule  to the Super Profits Tax Act, 1963 consists of three  rules while  the Second  Schedule to the Companies (Profits) Surtax  Act, 1964  consists  of  four  rules.  The relevant rules under both these Acts for our purposes are as follows : The Super Profits Tax Act. 1963 The Second Schedule      Rules for  computing the capital of      a company for the purposes of Super      Profits Tax:      "Rule  1:   Subject  to  the  other      provisions   contained    in   this      Schedule, the  capital of a company      shall   be    the   sum    of   the      amounts, as on the first day of the      previous  year   relevant  to   the      assessment  year,  of  its  paid-up      share      capital      and      of      its  reserve,  .................and      of     its      other      reserves      ................ diminished  by the      amount by which the         cost to      it of  the assets  the income  from      which  in  accordance  with  clause      (iii)  or  clause  (vi)  or  clause      (viii)  of  rule  1  of  the  First      Schedule is  not includible  in its      chargeable  profits,   exceeds  the      aggregate of -      (i)  any   money   borrowed   which      remains outstanding; and      (ii) the  amount of  any fund,  any      surplus and  any such reserve as is      not to  be taken  into  account  in      computing the               capital      under this rule.      ......................" The Companies (Profits) Surtax Act. 1964 The Second Schedule      "Rules for computing the capital of      __  company  for  the  purposes  of      surtax:      1. Subject  to the other provisions      contained  in  this  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      -      (i) its paid-up share capital;      (ii) its reserves............      2. Where  a company owns any assets      the income from which in accordance      with clause (iii) or clause (vi) or

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    clause (viii)  of  rule  1  of  the      First Schedule  is required  to  be      excluded from  its total  income in      computing      its       chargeable      profits, the  amount of its capital      as computed  under rule  1 of  this      Schedule shall be diminished by the      cost to it of the said assets as on      the first  day of the previous year      relevant to  the assessment year in      so far  as such  cost  exceeds  the      aggregate of -      (i) any moneys borrowed...........      (ii) the  amount of  any fund,  any      surplus and  any such reserve as is      not to  be taken  into  account  in      computing the  capital  under  rule      1.........." In the  present case,  the assessee  has earned  income from dividends as  envisaged in  clause (iii)  of Rule  1 of  the Second  Schedule.  The  assessee  contends  that  while  the capital involved  in  the  investment  in  shares  has  been deducted in  the computation  of its  capital the  amount of such capital  deducted should  reduced by the amount of "any fund, any  surplus and  any reserve" in terms of Clause (ii) of Rule  1 of  the Second  Schedule of the Super Profits Tax Act, 1963  and the corresponding clause of Rule 2(ii) of the Second Schedule of the Companies (Profits) Surtax Act, 1964. It is  contended that the provision made for taxation should be regarded  as  a  reserve  and  should  thus  be  included straightaway in  the computation of capital or otherwise, it should be deducted from the cost of investment in the shares which are  deducted from the computation of capital. In view of the  decision of  this  Court  in  Vazir  Sultan  Tobacco Co.Ltd. v.  Commissioner of Income Tax (l32 ITR 559 at 577), a provision  made to  meet the  tax liability of the current accounting year  cannot  be  considered  as  representing  a reserve. We,  however,  have  to  consider  the  alternative submission that  it  should  be  treated  as  a  fund,  and, therefore, should  be deducted  from the  cost of the assets required to be excluded from the capital of the company.      Since the  Second Schedule  to both these Acts pertains to computing  the capital  of a  company for the purposes of tax under  these Acts, the terms used in the Second Schedule need to  be interpreted  in the context of the balance sheet of a  company and  its profit  and loss  account which  will necessarily have  to be looked at to ascertain the company’s capital and  its profits. The terms used must, therefore, be read in the light of the provisions of the Companies Act and how these  terms are  understood in accounting parlance. The form of the balance sheet of a company prescribed under Schedule VI  tc the  Companies Act,  1956, under  the column "reserves and surplus" contains a note to the following effect:      "The word ’fund’ in relation to any      ’Reserve’ should be used only where      such   Reserve    is   specifically      represented by            earmarked      investments."      The juxtaposition  of funds  with surplus  and reserves clearly refers  to accounting  language and  the  manner  in which  these   three  terms  are  understood  in  accounting practice. Our attention is also drawn to the term "found" as described in  the Dictionary for Accountants, 4th Edition by Eric L.Kohler,  pages 204  to 208 as set out in the judgment

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of the  Calcutta High  Court in Duncan Brothers & Co.Ltd. v. Commissioner of Income- Tax, Central, Calcutta, (128 ITR 302 at 311) which is as follows :      "Fund. 1.  An  asset  or  group  of      assets  within   any  organization,      separated  physically   or  in  the      accounts or  both from other assets      and limited to specific uses.      Examples: a  petty-cash or  working      fund;   a   replacement-and-renewal      fund;   an    accident   fund;    a      contingent fund; pension fund.      2.  Cash,   securities,  or   other      assets placed  in the  hands  of  a      trustee,  principal  or  income  or      both being  expended in  accordance      with  the   terms   of   a   formal      agreement. Examples:  a trust  fund      created by  a  will;  an  endowment      found; a sinking fund.      3. (government  accounting) A self-      balancing  group   of  accounts  --      asset,   liability,   revenue   and      expense --  relating  to  specified      sources and  uses  of  capital  and      revenue.      4. pl.  Current assets less current      liabilities (on  an accrual basis):      working capital;  a  term  used  in      flow statements.      5. pl. = cash.      v.t.  1.   To   convert   currently      maturing liabilities  into a  long-      term loan.       2.  To provide  for  the  ultimate      payment  of   a  liability  by  the      systematic accumulation  of cash or      other assets  in a separate account      or trust.           A  special   revenue  fund  is      created   for   taxes   and   other      revenues levied  or set  aside  for      specified purposes. For example, if      a separate  tax is  authorized  for      schools, a  special revenue fund is      set   up   to   account   for   its      disposition.     The     accounting      principles,     procedures,     and      financial statements  of a special-      revenue fund  resemble those of the      general fund.......      Other Funds.      ------------      A balance-sheet  combining a  group      of related  funds  should  indicate      the amount  of assets, liabilities,      reserves and  surplus applicable to      each ,  fund within  the group. The      revenues and  expenditures of  each      fund   must    likewise   be   kept      independent, and  the  revenues  of      one fund should not be used to meet      the expenditures of another without      legal authority  or opinion  behind      the action."

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    In the present case there is no systematic accumulation of cash  or any  separation of  assets to  meet  future  tax liabilities. There  is only  an accounting entry of an exact sum being  earmarked for payment of tax liability arising at the end  of the  current accounting  year. Such  a provision cannot be considered as a fund.      The assessee  has relied  upon a Circular No.I.P.(XV-5) of 1968  dated 23rd  of January, 1968, issued be the Central Board  of  Revenue.  The  circular  deals  of  "reserve  for unexpired risks"  held by  General Insurance  Companies. The circular, inter alia, states as follows:       "The Board are advised that, while      the ‘reserve  for unexpired  risks’      cannot be  regarded as  a ’reserve’      or ’surplus’,  it would qualify for      being     considered      as      a      ’fund’ within  the meaning  of rule      2(ii) of  the said Second Schedule.      The  term   ’fund’,  it   will   be      observed,     has      not     been      defined in  the Companies (Profits)      Surtax Act, 1964. As such, it is to      be given  its ordinary  meaning  as      understood  in   common   parlance.      Etymologically, ’fund’ means aum of      money available  for the payment or      discharge of  liabilities.  As  the      ’reserve   for   unexpired   risks’      clearly represents  a sum  of money      available  to   the   company   for      payment or  discharge of unexpected      claims that may arise in respect of      policies which  extend  beyond  the      relevant   accounting   year,   the      amount standing  to the  credit  of      this account  can be  regarded as a      fund............"      This circular,  however, is  of no  assistance  in  the present case. In the first place. the provision for taxation made in  the present  case is  very different in nature from the reserve for unexpired risks referred to in the circular. The reserve  in that  case represented  a sum of money which would be  available to  the insurance company for payment or discharge of  unexpected claims that may arise in respect of policies  which  extend  beyond  the  accounting  year.  The provision for  taxation in the present case, however, is set apart to  meet a specific liability which would arise at the end of  the current  accounting  year.  It  cannot,  in  any manner, be compared to a fund of the kind referred to in the circular of the Board.      The assessee,  however, has submitted that the circular of the Board has taken the meaning of the term "fund" in its literal or  etymological sense.  Hence it must be applied to any sum  of money  available  to  the  company  including  a provision for taxation. The argument has no merit. The Board has  considered   the  etymological  meaning  of  "fund"  in considering a  reserve to meet future unexpired risks. A sum of money  set  apart  to  meet  such  unforeseen  risks  was considered as  a fund. We fail to see how the circular helps the assessee in the case before us. A provision for taxation of the  kind in question is not a fund either etymologically or in  accounting parlance. The more relevant meaning of the term "fund" in the context of the two Acts is what that term is commonly  considered to  connote when  used in  a balance sheet or  profit and  loss account  of a company. A specific

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provision for  an ascertained liability is not a fund within the meaning of that term in the rules in question.      In the  premises, Question No.2 for the assessment year 1963-64 and the question for the assessment year 1964-65 has to be  answered in  the affirmative  and in  favour  of  the revenue.  The   appeal  is   accordingly  allowed.   In  the circumstances, however, there will be no order as to costs.