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PETITIONER: COMMISSIONER OF INCOME TAX, KANPUR

       Vs.

RESPONDENT: SARAN ENGINEERING CO. LTD.

DATE OF JUDGMENT31/07/1986

BENCH: MUKHARJI, SABYASACHI (J) BENCH: MUKHARJI, SABYASACHI (J) PATHAK, R.S.

CITATION:  1986 AIR 1943            1986 SCR  (3) 398  1986 SCC  (3) 663        JT 1986     7  1986 SCALE  (2)112

ACT:      Computation of  capital-Super Profits  Tax  Act,  1963, Second Schedule-Whether  capital reserve,  stock and  stores Reserves, Bad  and doubtful  debts reserves,  Rehabilitation Reserve, Obsolescence  reserve, Loans and Insurance reserve, Investment reserve  and Forfeited  moneys reserves are to be included in the computation of capital reserve.      Company (Profits)  Surtax Act,  1964, Rule  (1) of  the Second Schedule-Computation  of the company law made-Whether the Gratuity  Reserve, Reserve  for Special  Survey, Reserve for contingencies,  Fleet Replacement  Reserve, Reserve  for exempted profits under section 84 of the Income Tax, Reserve for  investment   depreciation  and   Dividend  Equalisation Reserve etc. are includible.

HEADNOTE:      The assessee,  in CA  1546 of  1974, M/s  British India Corporation Ltd.  claimed capital Reserve, Stocks and Stores Reserves, Bad  and  doubtful  debts  Reserves,  Obsolescence reserve, Loans and Insurance reserve, investment reserve and forfeited moneys reserves as "standard deduction" as defined in section  2(a) of  the Super  Profits Tax Act, 1963 in the computation of  its profits  under the  relevant Income  Tax Act. The claim having been disallowed, the question has been referred to this Court by the Tribunal.      In Civil  Appeal  No.  1599/74  the  Saran  Engineering Company  Ltd.  claimed  similar  deductions  in  respect  of capital  reserve,  Rehabilitation  Reserve,  Stores  Reserve forfeited moneys Reserve and Bad and doubtful debts reserve. The Income  Tax Officer  rejected the  claim. On  appeal the Appellate Assistant  Commissioner allowed the claim in part. The Tribunal however allowed the assessee’s claim in full in further appeal  while rejecting the Revenue’s appeal against A.A.C’s order.  At the instance of the Revenue, the Tribunal referred the  matter to  the  High  Court.  The  High  Court answered the  reference partly  in favour  of the Revenue by negativing the claim as to forfeited moneys reserve and 399 restricting  the  quantum  of  amount  allowed  by  the  AAC regarding capital  reserve, as  the assessee  did not seek a reference against it. Hence the appeal by Revenue by Special

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Leave.      In the  Special Leave Petition No. SLP (C) 4815A/77 the High Court’s  rejection order of the revenue’s request under section 256(2) for calling for a case against the Tribunal’s findings regarding the Gratuity Reserve, Reserve for Sepcial Survey,  Reserve   for  contingencies,   fleet   Replacement reserve, Reserve  for exempted  Profits under  section 84 of the Income  Tax Act, Reserve for Investment depreciation and Dividend Equalisation  Reserve but allowing only in relation to the Reserve for special Survey come to be considered.      Allowing the  two civil  appeals in part and dismissing the Special Leave Petition, the Court ^      HELD: 1.  In the  facts and  circumstances of the case, except the  obsolescence Reserve  and the  forfeited  moneys reserve, all  the Reserves,  namely, capital Reserve, Stocks and Stores  Reserve, Bad  and doubtful debts reserves, Loans and   Insurance    Reserve,    Investment    reserve,    and rehabilitation reserve are to be included in the computation of  capital  according  to  the  provisions  in  the  Second Schedule to the Super Profits Tax Act, 1963.      2.  Where   the  liability   has  actually   arisen  or anticipated legitimately  by the assessee though the quantum of the  liability has  not been  determined,  to  meet  such present liability  cannot be  treated as  "reserve". A fund, however, created  for payment  of a  liability which had not already arisen  or fallen  due but  orly  a  provision  with regard to  the sum  that might  become liable  to be paid is "other reserve  within the  meaning of  rule (1)  of  second schedule and  should be  taken into account in computing the capital of  the company  for the  purpose of  the  Companies (Profit) Surtax  Act, 1964.  Except  the  item  relating  to Reserve for  special survey, it is not necessary to call for any statement  of the  case in respect of other items in SLP (C) 4815A/77. [406G-H; 407A]      Commissioner of  Income Tax,  Kanpur v. The Elgin Mills Ltd., Kanpur, [1986] 3 SCR P. 408, followed.

JUDGMENT:      CIVIL APPELLATE  JURISDICTION: Civil Appeal No. 1599 of 1974 400      From the  Judgment and  Order dated  19.7.1973  of  the Allahabad High Court in I.T. Reference No. 200 of 1971.                             and      Civil Appeal No. 1546 of 1974      From the  Judgment and  Order dated  21.7.1972  of  the Allahabad High Court in I.T. Reference No. 172 of 1971.      S.L.P. No. 4815A of with 1977      B.B. Ahuja for the Appellant in C.A. No. 1599 of 1974.      Dalip Singh,  Ms. A.  Subhashini and  K.C. Dua  for the Appellant in  C.A. No.  1546 of 1974 and S.L.P. No. 4815A of 1977.      Harish Salve,  K.J. John,  Ranjit Kumar  and B.P. Singh for the Respondents.      The Judgment of the Court was delivered by      SABYASACHI MUKHARJI,  J. In  Civil Appeal  No. 1546  of 1974 the  following items were involved: (a) Capital Reserve (b) Stocks  and stores  reserves, (c) Bad and doubtful debts reserves, (d)  Obsolescence reserve, (e) Loans and Insurance reserve (f)  Investment reserve  and  (g)  Forfeited  moneys reserves. The question was whether these were to be included in the computation of capital according to the provisions in

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the second schedule to the Super Profits Tax Act, 1963.      Under Section  4 of  the Super  Profits Tax  Act, 1963, every company  shall be  charged for  every assessment  year commencing from  1st April,  1963 a tax as Super Profits tax in respect  of so  much of  its  chargeable  profit  of  the previous year  as exceed the standard deductions at the rate or  rates   specified  in   the  third  schedule.  ’Standard deduction’ had  been defined  in clause  (9) of section 2 as follows:           "An amount equal to six per cent of the capital of           the company  as computed  in accordance  with  the           provisions of the second schedule; on an amount of           Rs.50,000 whichever is greater."      The second  schedule contained rules for computation of capital of a company for the purpose of the said Act. 401      None of  the reserves  claimed by the assessee had been allowed as  deductions in  the computation  of  its  profits under the  relevant Income-tax Act. The question was whether these represented reserves.      The Tribunal  has referred  to this Court the following question:           "Whether, on the facts and in the circumstances of           the case,  the Tribunal was right in holding that:           (a)  Capital   Reserve,  (b)   Stocks  and  stores           reserves, (c)  Bad and  Doubtful debts reserve (d)           Obsolescence  reserve,  (e)  Loans  and  Insurance           reserves, (f) Investment reserve and (g) Forteited           moneys  reserves   were  to  be  included  in  the           computation of capital according to the provisions           in the  second schedule  to the  Super Profits Tax           Act, 1963?"      We must observe that so far as the capital reserves are concerned, in  view of  the findings  recorded by  the  High Court that  the amount  represented reserve  and it  was not ear-marked for  any existing liability for being utilised by the company, it must be held to be reserve.      The capital  reserve which  was a  sum of Rs. 11,73,952 consisted of  two amounts namely Rs.12,212 and Rs.11,61,770. The amount  of  Rs.12,212  represented  an  insurance  claim received by  the assessee company on account of a fire which had destroyed  some assets of the assessee company. The said receipt of  fire insurance  claim has directly been credited to the  capital account  and the  sum  of  Rs.11,61,770  was credited by  transfer from  the Profit & Loss Account in the earlier  years.  This  was  not  provided  for  against  any existing or  future liability.  It was  rightly  treated  as capital reserve.      The next  item was  Stocks and Stores Reserve. This was created in  1950  by  transfer  from  the  Profit  and  Loss Appropriation Account.  This did  not represent any existing provision  for  existing  liability  to  meet  any  specific contingency for safeguarding against diminution of the value of the  stocks and stores. It was in the nature of a reserve for safeguarding  against any  possible  diminution  of  the value of  stocks and  stores on  any future occasion. In our opinion, the Tribunal was right in treating it as reserve.      Bad and  Doubtful Debts  Reserve was  created  in  1956 through the  Profit  and  Loss  Appropriation  Account.  The amount involved was 402 Rs.5,00,000. It  was submitted  on behalf of the assessee by Shri Salve  that this  was  created  by  transfer  from  the Appropriation Account  and  not  a  charge  against  profit. Furthermore, a  separate provision  was  made  for  bad  and

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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 very nomenclature this was not a reserve. True nature of the transaction has to be examined.      The next  item is  Obsolescence Reserve of Rs.1,72,259. This  was   created  in   1959  by  transferring  a  sum  of Rs.12,05,000 from  the Profit and Loss Account. Some amounts were written  off out of this reserve in 1960 and 1961. This appears  to  be  provision  to  meet  future  liability  and contingency. But  there are  not much facts about it. Had it been necessary we might have remanded the matter to the High Court to  direct the  Tribunal to find facts on this aspect. But as in that view of the matter, this item was not pressed before us,  so this  item is  deleted from  reserve  of  the assessee.      So far as Loan and Insurance Reserve is concerned, this was created  prior to  1947. It  was found  that it was free from any  burden and it was not utilised for any purpose and was transferred  to the  General Reserve  Account  in  1963. Therefore, it was rightly treated, in view of the principles mentioned hereinbefore as reserve.      The next  item is  Investment Reserve.  This  fund  was created out  of the  surplus on the sale of investment which was not  held by  the respondent  company as  its  stock  in trade. The  surplus did  not have  its  origin  in  business profits and  was transferred directly to the reserve account but this  was created prior to 1954 and was further credited in 1955  to 1957  out of the profits on sale of investments. In the  later years, whenever a loss of a capital nature was incurred it  was debited to this account. It appears that at the time  of creating  this Reserve, the Directors could not have possibly  anticipated the  losses which  might occur in future but  merely created a reserve so that losses which do normally arise  in the  course of business might be adjusted against this  amount. It  appears therefore  that this was a reserve created  out of the capital profit. This reserve can rightly be treated as other reserves.      Forfeited moneys  reserve, in  our opinion,  cannot  be treated as 403 reserve, and the High Court has also not treated it as such. In that  view of  the matter  except the  item indicated  as Obsolescence Reserve  which is  deleted from  the reserve as indicated before,  we uphold  the order  of the  High Court. This appeal  is dismissed  subject to  the extent  indicated above. There will be no order as to costs.      In Civil  Appeal No.  1599 of 1974, the following facts were recorded:           "The assessee is a limited company. In proceedings           under the Super Profit Tax Act, 1963, the assessee           claimed that  the following  amounts appearing  as           credit balances  in the various accounts mentioned           against each  be treated  as reserves and included           in the  capital of the company for the purposes of           determining   the    standard    deductions,    as           contemplated under section 2(9) of the Act:           (a) Capital reserve                 Rs.9,41,488           (b) Rehabilitation reserve          Rs.6,00,000           (c) Stores reserve                  Rs.  75,000           (d) Forfeited moneys reserve        Rs.   8,000

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         (e) Bad and doubtful debts reserve  Rs.  25,000      The Income-tax  Officer rejected  the assessee’s claim. On appeal  the Appellate  Assistant Commissioner allowed the claim of  the assessee in part. The revenue and the assessee both went up in appeal before the Tribunal. The Tribunal had allowed the  claim of  the assessee  in  full.  The  revenue feeling aggrieved  referred the  following question  to  the High Court:           "Whether, on the facts and in the circumstances of           the case, the Tribunal was right in holding that:           (a) Capital reserve           (b) Rehabilitation reserve,           (c) Stores Reserve           (d) Forfeited moneys reserve; and           (e) Bad and doubtful debts reserve, 404           were to  be included  in  computation  of  capital           according to the provisions of the second Schedule           to the Supper Profits Tax Act (Surtax) 1963."      So far  as the  capital reserve  is concerned,  in  the light of  discussion in  Civil Appeal  No. 1665 of 1974-CIT, Kanpur v.  The Elgin  Mills Ltd.,  Kanpur (Infra p. 408) and also in  Civil Appeal  No. 1546  of 1974- CIT, Kanpur v. M/s British India  Corporation Ltd., the High Court was right in treating this  account as  reserve. It must be further noted that so  far as capital reserve was concerned, the Appellate Commissioner had allowed a sum of Rs.7,19,488 out of a claim of Rs.9,41,488.  In appeal, the Tribunal upheld the order of the Appellate  Commissioner. The  assessee did  not  seek  a reference against  this in  the High  Court. The controversy before the  High Court  was confined to the claim allowed by the Appellate Commissioner. The High Court held in favour of the assessee  in treating  it a  reserve. The High Court was right.      So far as the rehabilitation reserve and stores reserve are concerned,  in view  of the  facts found by the Tribunal and in  the light  of the  reasons indicated in Civil Appeal No. 1546  of 1974,  in our  opinion, this must be treated as reserve as was held by the Tribunal.      The High  Court  has  disallowed  the  forfeited  money reserve to be treated as reserve. We are of the opinion that the High Court was right.      So far  as Bad and Doubtful Debts are concerned, in the light of  the observations  made in Civil Appeal No. 1546 of 1974 and  in the  light of  the facts  found, this  must  be treated as reserve.      In the  aforesaid view  of the matter, the appeal fails and is accordingly dismissed. In the facts and circumstances of the case, there is no order as to costs.      Special Leave  Petition No. 4815A of 1977 arises out of the decision  of the  Bombay High Court where the High Court rejected the application under section 256(2) of the Income- tax  Act,  1961,  for  an  order  directing  the  Income-tax Appellate Tribunal,  Bombay to  state a  case in relation to the various  items specified  in the  question. The question was as follows:           "Whether, on the facts and in the circumstances of           the 405           case, the  Tribunal  was  right  in  holding  that           Gratuity A  Reserve  of  Rs.2,00,000  Reserve  for           Special  Survey   of  Rs.13,04,600,   Reserve  for           Contingencies of  Rs.56,00,000. Fleet  Replacement           Reserve  of  Rs.54,35,250,  Reserve  for  exempted           profits under  section 84  of Rs.1,64,900, Reserve

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         for Investment  depreciation  of  Rs.7,09,144  and           Dividend Equalisation  Reserve of Rs.2,00,000 were           reserves with  the meaning  of the Second Schedule           to the Act?"      The Tribunal  by  its  order  dated  21st  July,  1976, rejected this  application as one of fact and the principles not being in dispute.      The revenue  thereafter applied to the High Court under section 256(2)  of the  Act read  with  section  18  of  the Companies (Profits)  Surtax Act,  1964. By  its order  dated 20th  June,   1977,  the   Bombay  High  Court  allowed  the application only  in relation  to the  Reserve  for  Special Survey for  Rs.13,04,600 and rejected the application so far as other items are concerned.      Being aggrieved, the assessee has come in Special Leave Petition. The  facts regarding  the same  as  found  by  the Tribunal are as follows:           "(i)  The  Gratuity  Reserve  of  Rs.2,00,000  was           created for  the first  time during  the preceding           year.  The  amount  was  not  claimed  as  revenue           expenditure.  Some  payments  were  actually  paid           during the  preceding accounting  year. The amount           was to  be included  in the capital base as "other           Reserves".           (ii) Reserve for Special Survey: Rs.13,04,600: The           balance in  this reserve  account on the first day           of the  preceding accounting  year was Rs.9,32,500           to which  was added  Rs.15 lakhs  by transfer from           the Profits  and Loss  Account making  a total  of           Rs.24,32,500. During  that preceding year expenses           of Rs.11,26,900  were incurred and debited to this           reserve  and   the  balance  of  Rs.13,04,600  was           carried forward. This amount was to be included in           the capital base.           (iii)  Reserve  for  contingencies:  Rs.56,00,000:           This reserve  account was  meant to be utilised in           case of  contingencies and  there was  no specific           liability for spending even a part 406           of this  amount on the first day of the accounting           year  and  it  was  therefore  includible  in  the           capital base.           (iv) Fleet replacement reserve: Rs.54,35,250: This           reserve was  like the  reserve for  contingencies.           Here also  there  was  no  liability  in  presenti           towards purchase of any vessel on the first day of           the  accounting   year  and   this  sum  also  was           includible in the capital base.           (v) Reserve  for exempted profits under section 84           of the  Income-tax Act:  Rs.1,64,900: This was not           meant for  meeting any liability and had therefore           to be included in the capital base.           (vi)   Reserve    for   investment   depreciation:           Rs.7,09,144: This  reserve was  created originally           in order  to cushion the effect of fluctuations in           the prices  of  foreign  securities  held  by  the           assessee. This  amount was  ultimately transferred           in 1971  to the  Profits  and  Loss  Appropriation           Account. Here  also the reserve was not created by           way of  making  provision  for  liability  already           accrued  on   or  before  the  first  day  of  the           accounting year  and had  therefore to be included           in the capital base.           (vii) Dividend  Equalisation Reserve: Rs.2,00,000:           This reserve  was set apart to enable the assessee

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         to declare reason able dividend in a year in which           the profit  was likely to go down. This amount was           subsequently transferred to the General Reserve in           1971. This  amount was  also to be included in the           capital base."      In view of the facts as recorded by the Tribunal and in the light of the principles settled by various decisions and reiterated by  this Court  in Civil Appeal No. 1665 of 1974, (supra) it is not necessary to call for any statement of the case and  the High Court was right. It may be mentioned that where the  liability  has  actually  arisen  or  anticipated legitimately by  the assessee  though  the  quantum  of  the liability has  not been  determined, to  meet  such  present liability cannot  be treated  as ’reserve’. A fund, however, created for  payment of  a liability  which had  not already arisen or fallen due but only a provision with regard to the sum that  might become  liable to  be paid is ’other reserve within the meaning of rule (1) of second schedule and should be taken into ac- 407 count in  computing the  capital  of  the  company  for  the purpose of the Companies (Profit) Surtax Act, 1964.      In that  view of the matter, we are of the opinion that the decision  of the  High Court  was right.  The principles applicable in  these types  of cases  have been discussed by this Court  in several  decisions. It  is not  necessary  to reiterate these again.      In  the   premises  this   application  fails   and  is accordingly dismissed.  In the  facts of  this case, parties will pay and bear their own costs. S.R.                                Appeals allowed in part. 408