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CASE NO.: Appeal (civil) 3825 1999

PETITIONER: COMMISSIONER OF INCOME TAX, TRIVANDRUM

       Vs.

RESPONDENT: M/S.  TRANVANCORE TITANIUM PRODUCTS LTD.

DATE OF JUDGMENT:       07/12/2000

BENCH: Y.K.Sabharwal, D.P.Mohapatro, S.P.Bharucha

JUDGMENT:

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     J U D G M E N T

     Y.K.Sabharwal, J.

     This appeal has been filed by the revenue to challenge the  correctness of the judgment and order of the High Court of  Kerala  dated  18th August, 1998.  The case  relates  to assessment  year 1985-86.  On reference under Section 256(1) of  the Income Tax Act, 1961 as applied to surtax by Section 18 of the Companies (Profits) Surtax Act, 1964 the questions that arose for consideration of the High Court were:

     "(a) Whether, on the facts and in the circumstances of the  case, the Appellate Tribunal is right in law in holding that  the loan redemption reserve amount to Rs.1 crore is  a reserve  and  not a provision and is to be included  in  the computation of capital for the purpose of surtax?

     (b)  Whether, on the facts and in the circumstances of the  case  and in view of the Supreme Court decision in  the case  of  Vazir Sultan Tobacco Co.Ltd.  (132 ITR  559),  the Appellate Tribunal is right in holding so?"

     By  the impugned judgment the High Court answered  the questions  in  the  affirmative, that is, in favour  of  the respondent-assessee and against the revenue.

     The  respondent had obtained Rs.491 lakhs as loan from Government  of Kerala from 1968 to 1983 for the expansion of the Titanium Dioxide Plant.  It could repay upto March, 1987 only  a  sum  of Rs.115.50 lakhs.  The balance of  the  loan outstanding as on 31st March, 1987 was Rs.377.50 lakhs which included  a sum of Rs.245 lakhs being overdue instalment  of principal from 1983 onwards.  Out of the sum of Rs.245 lakhs outstanding,  two  instalments totalling Rs.102  lakhs  were repaid  to  the Government during June 1987 and the  arrears

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due  to the Government towards principal of the loan  amount as  on the date of the presentation of the annual report  of the company for the financial year 1986-87 was Rs.143 lakhs. The  assessing  authority disallowed the sum of  Rs.1  crore standing  in the credit side under the head ‘loan redemption reserve’  holding that even if it is conceded that it is  an appropriation  from  profit  by way of a fund even  then  it partakes  the nature of the ‘sinking fund’ only which can be only  for clearing of an ascertained liability.  It  further held  that  the  fact  that a sum has  been  set  apart  for redeeming liabilities makes it obvious that the intention is for  clearing  a liability and not acquiring an asset.   The assessing  authority  held the amount was a ‘provision’  and not  a ‘reserve.  The appeal preferred by the respondent was dismissed on 31st January, 1990 and the assessment order was upheld  by  the Commissioner of Income-tax  (Appeals).   The Income-tax  Appellate Tribunal, however, by order dated 25th September,  1991  allowed  the appeal of  the  assessee  and directed  the assessing officer to include the sum of Rs.  1 crore  in  the  capital of the company for  the  purpose  of surtax.   The Tribunal held that there was no stipulation by the  Government for the creation of loan redemption reserve; on  its  own volition the assessee had been creating a  loan redemption  reserve by making an appropriation of profit  of Rs.10  lakhs  each  year  beginning from  1970;   the  total reserve amount to Rs.100 lakhs remained undisturbed till the year  1987 and in the year 1988 the same was transferred  to the general reserve and that the amount appropriated was not against  the profits but was from out of the profit and  the loan  redemption  reserve did not bring into  existence  any fresh  liability  because  the   liability  was  already  in existence.   These are the circumstances under which the two questions  noticed above were answered by the High Court  in favour of the respondent-assessee.

     The  point  for  determination  is  whether  the  loan redemption  reserve amount to Rs.1 crore is a reserve or  it is  a  ‘provision’.  It may be noticed that the tribunal  in its  order had also relied upon the decision of the Calcutta High  Court  in C.I.T.  v.  Pieco Electronics &  Electricals ([1987]  166 ITR 299).  That decision has also been referred in the impugned judgment of the High Court.  The decision of the  Calcutta  High Court in Pieco Electronics  (supra)  has been  overturned by this Court in National Rayon Corporation Ltd.   v.  Commissioner of Income-tax ([1997] 227 ITR  764). Relying   upon   Vazir   Sultan   Tobacco  Co.    Ltd.    v. Commissioner  of Income-tax, A.P.  ([1981] 132 ITR 559)  the Court  rejected  the  contention that if the  redemption  or appropriation  of a sum out of profits and surpluses was for a  unknown liability or for a liability which did not  exist on the relevant date, it must be regarded as a reserve.  The contention  was  held  to be  fallacious.   The  expressions ‘provision’  and  ‘reserve’  have not been  defined  in  the Companies  (Profits)  Surtax Act, 1964.  After referring  to the  dictionary meaning of these expressions and bearing  in mind  the  distinction between the two concepts as known  in the  commercial  accountancy and decision of this  Court  in C.I.T.   v.   Century  Spinning   &  Manufacturing   Co.Ltd. ([1953]  24 ITR 499) and Metal Box Company of India Ltd.  v. Their  Workmen  ([1969]  73  ITR 53) it was  held  in  Vazir Sultan’s case (supra):

     "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 p & l

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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 the Companies Act, 1956.

     Under  s.210  of  the  Companies   Act,  1956,  it  is incumbent  upon  the board of directors of every company  to law  before the annual general meeting of its  shareholders, (a)  the  annual balance-sheet, and (b) the profit and  loss account  pertaining to the previous financial year.  Section 211 (1) provides that every balance-sheet of a company shall give  a  true and fair view of the state of affairs  of  the company  as  at  the end of the financial  year  and  shall, subject  to  the provisions of this section, be in the  form set  out  in  Pt.   I  of  Sch.   VI,  or  near  thereto  as circumstances admit or in such other form as may be approved by  the Central Govt.  either generally or in any particular case,  while s.  211 (2) provides that every profit and loss account  of a company shall give a true and fair view of the profit  or  loss of the company for the financial  year  and shall, subject as aforesaid, comply with the requirements of Pat.  II of Sch.  VI, so far as they are applicable thereto. In  other words the preparation of balance-sheet as well  as profit  and loss account in the prescribed forms and  laying the  same  before  the shareholders at  the  annual  general meeting  are statutory requirements which the company has to observe.   The  form of balance-sheet as given in Pt.  I  of Sch.  VI contains separate heads of "Reserves and Surpluses" and  "Current  Liabilities  and Provisions"  and  under  the sub-head   "Reserves"  different  kinds   of  reserves   are indicated and under sub-head "Provisions" different types of provisions  are  indicated!  Part III is the  interpretation clause  setting  out the definitions of various  expressions occurring  in  Pts I and II and the  expressions  "reserve", "provision"  and  "liability"  have  been  defined  in  cl.7 thereof.  Material portion of cl.7 of Pt.III runs as under:

     ‘(1)  For  the  purposes  of Parts I and  II  of  this Schedule, unless the context otherwise requires,-

     (a)  the  expression  ‘provisions’ shall,  subject  to sub-clause  (2) of this clause, mean any amount written  off or  retained by way of providing for depreciation,  renewals or  diminution  in  value of assets, or retained by  way  of providing for any known liability of which the amount cannot be determined with substantial accuracy;

     (b)  the  expression ‘reserve’ shall not,  subject  as aforesaid, include any amount written off or retained by way of  providing  for depreciation, renewals or  diminution  in value  of  assets  or retained by way of providing  for  any known  liability;   ........   and in  this  sub-clause  the expression  ‘liability’  shall  include all  liabilities  in respect  of  expenditure contracted for an all  disputed  or contingent liabilities.

     (2)  Where- (a) any amount written off or retained  by way  of providing for depreciation renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act;  or (b) any  amount  retained  by  way of providing  for  any  known liability;   is in excess of the amount which in the opinion of  the directors, is reasonably necessary for the  purpose,

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the  excess  shall  be  treated for  the  purposes  of  this Schedule as a ‘reserve’ and not a ‘provision’.

     On  a  plain reading of cl.  7(1)(a) and (b)  and  cl. 7(2)  above  it  will  appear clear  that  though  the  term "provision"  is  defined  positively by specifying  what  it means  the  definition of "reserve" is negative in form  and not  exhaustive in the sense that it only specifies  certain amounts  which are not to be included in the term "reserve". In  other  words the effect of reading the  two  definitions together  is that if any retention or appropriation of a sum falls within the definition of "provision" it can never be a reserve  but  it  does not follow that if the  retention  or appropriation  is  not  a provision it  is  automatically  a reserve  and  the  question will have to be  decided  having regard  to  the  true  nature and character of  the  sum  so retained  or  appropriated  depending   on  several  factors including the intention with which and the purpose for which such  retention  or appropriation has been made because  the substance  of  the  matter  is to be regarded  and  in  this context the primary dictionary meaning of the term "reserve" may  have  to be availed of.  But it is clear  beyond  doubt that  if  any retention or appropriation of a sum is  not  a provision,  that is to say, if it is not designated to  meet depreciation,  renewals or diminution in value of assets  or any  known liability the same is not necessarily a  reserve. We  are emphasising this aspect of the matter because during the  hearing almost all counsel for the assesses strenuously contended  before us that once it was shown or became  clear that  the retention or appropriation of a sum out of profits and  surpluses  was  for  an  unknown  liability  or  for  a liability  which did not exist on the relevant date it  must be  regarded  as  a  reserve.  The  fallacy  underlying  the contention   becomes   apparent   if    the   negative   and non-exhaustive  aspects  of  the definition of  reserve  are borne  in mind.  Having regard to the type of definitions of the  two concepts which are to be found in cl.7 of Pt.   III the  proper approach in our view would be first to ascertain whether  the particular retention or appropriation of a  sum falls  within the expression "provision" and if it does then clearly  the concerned sum will have to be excluded from the computation  of  capital,  but  in  case  the  retention  or appropriation  of the sum is not a provision as defined, the question  will  have to be decided by reference to the  true nature  and character of the sum so retained or appropriated having  regard to several factors as mentioned above and  if the concerned sum is in fact a reserve then it will be taken into account for the computation of capital."

     In view of the aforestated legal position, the aspects taken into consideration by the tribunal and affirmed by the High  Court that there was no stipulation by the  Government for  creation of loan redemption reserve;  that the assessee had  not  kept  to  the schedule for  repayment;   that  the assessee, on its own volition, had created a loan redemption reserve  by  making appropriation of profit of  Rs.10  lakhs each  year  beginning  from 1970;  that  the  total  reserve amounting to Rs.100 lakhs remained undisturbed till the year 1987  and  in  the  year 1988 the same  was  transferred  to general  reserve and that the balance sheet showed that  the amounts  credited to the ‘loan redemption reserve’ were  not invested  outside  the  company   but  remained   internally invested,  on  the  facts  found,   were  not  relevant  for

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determining  as  to  whether  the amount  was  an  asset  or provision.   As  held  in Vazir Sultan the true  nature  and character  of  an  appropriation has to be  determined  with reference  to  the  substance of the matter, one  must  have regard to the intention with which and the purpose for which the  appropriation has been made, such intention and purpose being  gathered  from  the surrounding  circumstances.   The Vazir Sultan’s case (supra) also holds that if any retention or  appropriation  of a sum falls within the  definition  of ‘provision’ it can never be a reserve but it does not fallow that  if the retention or appropriation is not a ‘provision’ it  is  automatically a reserve.  The fact that  amount  has been  set  apart for redeeming liabilities makes it  obvious that  the  intention  is for clearing  liabilities  and  not acquiring  an  asset.  Bearing in mind these aspects, it  is clear  that  the amount in question cannot be regarded as  a ‘reserve’.  It has to be regarded as a ‘provision’.  Clearly the  amount was set apart to meet a loan liability.  It  may also  be noticed that the amount set apart is less than  the respondent’s  liabilities.   It  cannot be  regarded  as  an asset.   The decision in Vazir Sultan’s case (supra) was not correctly  appreciated by the High Court.  In this view, the questions deserve to be answered in the negative.

     For  the  aforesaid reasons, we allow the  appeal  and answer  the questions in the negative, that is, in favour of the revenue and against the assessee, upholding the order of the assessing authority.  The parties are left to bear their own costs.