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PETITIONER: LIFE INSURANCE CORPORATION LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX, DELHI &RAJASTHAN

DATE OF JUDGMENT: 09/12/1963

BENCH: SARKAR, A.K. BENCH: SARKAR, A.K. HIDAYATULLAH, M. SHAH, J.C.

CITATION:  1964 AIR 1403            1964 SCR  (5) 880  CITATOR INFO :  R          1965 SC1004  (13,16)

ACT: Income Tax Act (XI of 1922), s. 10(7) and Schedule rr.  2(b) and   3(b)-Direction   for  readjustment   by   income   tax officer--If officer has power.

HEADNOTE: The   appellant  transferred  a  certain  amount  from   its Consolidated Revenue Account to the Investment Reserve  Fund which   it  was  entitled  to  do;  By  this  transfer   the appellant’s  surplus  on which tax has to  be  assessed  was reduced.   The Income-tax Officer directed the appellant  to reduce  the  transfer by a certain  amount.   The  appellant challenged this direction. Held  :  (per Sarkar and Shah, JJ.) The  assessment  of  the profits  of an insurance business is by s. 10(7) of the  Act completely governed by the rules in the Schedule to the  Act and  there is no general power in the Income-tax Officer  to correct  any error apart from these rules.  Of these  rules, rr. 2(b) and 3(b) were relevant to the present case. 881 Under r. 2(b) of the Schedule the Income-tax Officer had  no power  to change the figures in the account of the  assessee while r. 3(b) only compelled the Income-tax Officer to allow certain deductions and to include certain amounts in  making the   assessment.   None  of  these  rules   warranted   the adjustment  of  accounts  made by  the  Income-tax  Officer. Neither was it justified by the proviso to r. 3(b). (Per Hidayatullah J.)., (i) The Income-tax Act  contemplates that the assessment of insurance companies should be carried out  not according to the ordinary principles applicable  to business  concerns as laid down in s. 10 of  the  Income-tax Act. (ii)  If  the  Income-tax Officer doubts  the  accounts  his powers  are defined by the proviso to r. 3(h).  The  proviso requires  him to consult the Controller of  Insurance.   The proviso negatives the existence of a separate general power. Action  has  to  be taken in the manner  laid  down  in  the proviso or not at all. (iii)  In  the present case the Income-tax Officer  did  not

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follow  the  proviso  at  all  and  therefore  the  impugned adjustment was improperly made.

JUDGMENT: CIVIL APPELLATE JURISDICTION : Civil Appeals No. 678-680  of 1962. Appeal  from the judgment dated March 2, 1960 of the  Punjab High Court (Circuit Bench) at Delhi in Income-tax  Reference No. 6-D of 1957. M.C.  Setalvad.  Bishan Narain, R.J. Kolah and  K.L.  Hathi, for the appellant. Gopal Singh and R.N. Sachthey, for the respondents. December  9,  1963.  The Judgment of A.K. Sarkar,  and  J.C. Shah, JJ. was delivered   by Sarkar,   J. M. Hidayatullah,J. delivered a separate opinion. SARKAR, J.-We think that these appeals should be allowed. The  appeals  relate to the assessment to incometax  of  the income  of  the  life  insurance  business  of  the   Bharat Insurance  Co.  Ltd.  now  merged  in  the  Life   Insurance Corporation  Ltd.  The assessment years concerned are  1952- 53,  1953-54  and 1954-55.  The Income-tax Act,  1922  makes special provision for assessment of the income of  insurance business.   The Income-tax Officer in making the  assessment orders made some adjustments in the accounts which 1/SCI/64-56 882 the  appellant contends, he has no power to do  under  these provisions.  The question in these appeals is whether he had the power to make these adjustments. Sub-section  (7)  of  s. 10 of the  Act  makes  the  special provision  for  the assessment of the  income  of  insurance business and that is in these terms:               "Notwithstanding  anything  to  the   contrary               contained  in Section 8, 9, 10, 12 or 18,  the               profits and gains of any business of insurance               and the tax payable thereon shall be  computed               in accordance with the rules contained in  the               Schedule to this Act." Rule 2 in the Schedule lays down in clauses (a) and (b)  two different methods for calculating the profits and gains of a life insurance business and provides that whichever of these two methods results in larger profits being arrived at,  has to  be  adopted.  The relevant portion of r. 2 is  in  these terms:                Rule  2.  "The  profits  and  gains  of  life               insurance  business  shall  be  taken  to   be               either-               (a) the  gross  external  incomings   of   the               preceding year  from  that  business  less the               management expenses of that year, or               (b)   the   annual  average  of  the   surplus               arrived at by adjusting the surplus or deficit               disclosed  by the actuarial valuation made  in               accordance with the Insurance Act, 1938 (IV of               1938)  in respect of the last  inter-valuation               period  ending before the year for  which  the               assessment is to be made..................  so               as  to exclude from it any surplus or  deficit               included therein which was made in any earlier               inter-valuation  period  and  any  expenditure               other  than  expenditure which may  under  the               provisions of s. 10 of this Act be allowed for               in  computing  the  profits  and  gains  of  a

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             business,               whichever is the greater:" 883 Then  follows a proviso which sets out a certain  limit  for management  expenses to be allowed but that is not  material for  this  judgment.  It is not in dispute that  the  method laid down in cl. (b) would in the present cases produce  the larger  income  and  had, therefore, to  be  followed.   The relevant part of r. 3 of the Schedule on which the arguments in these cases turn may now be set out.               Rule 3. "In computing the surplus for the pur-               pose of rule 2,-                (a) ..............................               (b)any  amount either written off or  reserved               in  the  accounts  or  through  the  actuarial               valuation  balance sheet to meet  depreciation               of or loss on the realisation of securities or               other assets shall be allowed as a  deduction,               and any sums taken credit for in the  accounts               or   actuarial  valuation  balance  sheet   on               account  of  appreciation of or gains  on  the               realisation of the securities or other  assets               shall be included in the surplus:               Provided that if upon investigation it appears               to  the Income-tax Officer after  consultation               with  the Controller of Insurance that  having               due   regard  to  the  necessity  for   making               reasonable    provision   for    bonuses    to               participating    policy-holders    and     for               contingencies,  the rate of interest or  other               factor  employed in determining the  liability               in   respect   of  outstanding   policies   is               materially inconsistent with the valuation  of               the securities and other assets so as  artifi-               cially to reduce the surplus, such  adjustment               shall   be   made   to   the   allowance   for               depreciation  of,  or  to  the  amount  to  be               included   in  the  surplus  in   respect   of               appreciation  of,  such securities  and  other               assets, as shall increase the 884               surplus  for the purposes of these rules to  a               figure which is fair and just;" No other rule in the Schedule was referred to at the bar. What had happened was this.  The assessee had debited a  sum of  Rs.  18,75,000 to its Consolidated Revenue  Account  and credited  it  to the Investment Reserve Fund.  There  is  no dispute  that  the assessee had to maintain  the  Investment Reserve  Fund.   The  transfer had  been  made  because  the assessee thought that the securities in respect of which the Investment   Reserve  Fund  had  been   constituted   having depreciated  the  fund  had  become  inadequate.   By   this transfer the assessee’s surplus, on which the tax had to  be assessed  under r. 2, was reduced.  The  Income-tax  Officer thought   that  this  transfer  made  the  balance  in   the Investment Reserve Fund exceed the deficit disclosed on  the book  values of the securities in that fund by  Rs.  30,420. He  also checked up the market value of the  securities  and came to the conclusion that they had been undervalued in the books by the assessee.  In his view, the Investment  Reserve Fund was for the aforesaid reasons actually in excess by Rs. 1,89,185  of  the  amount which it should have  had  to  its credit.  He, therefore, directed that the transfer from  the Revenue Account to the Investment Reserve Fund be reduced by Rs.  1,75,000.   The  assessee  appealed  to  the  Appellate

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Assistant Commissioner and lie directed that the transfer to the  Investment  Reserve  Fund be reduced  by  Rs.  1,45,000 instead  of  Rs.  1,75,000.   On a  further  appeal  by  the assessee  to the Income-tax Appellate Tribunal, it was  held that the adjustment could only be made under the proviso  to r. 3(b) of the Schedule and that that rule required a  prior consultation  with the Controller of Insurance, and as  that had  not been made, the adjustment was wholly illegal.   The Tribunal,  therefore,  ordered  that  the  transfer  of  Rs. 18,75,000  made  by  the assessee as  aforesaid  had  to  be accepted as a whole. The Commissioner then applied to the Tribunal under s. 66(1) to state a case but that having been 885 rejected  he moved the High Court of Punjab for an order  on the  Tribunal  to state a case tinder s. 66(2) of  the  Act. The High Court made an order on the Tribunal and the  latter thereupon  stated  a  case setting  out  the  facts  earlier mentioned  and referring the following question to the  High Court for its decision:               "Whether upon the facts found by the Tribunal,               the  Income-tax  Officer  had  in  this   case               jurisdiction to proceed to make adjustment  in               terms of r. 3(b) of the Schedule to the Indian               Income-tax Act." The  High Court took the view that the matter did  not  come within  r. 3(b) of the Schedule and, therefore, no  question of consultation with the Controller of Insurance arose.   In the High Court’s opinion the Income-tax Officer had not been deprived  of the authority of correcting errors of the  kind that  had been detected in these cases and the  proviso  was not intended to cover those cases where, as in the  present, the  assessee in order to evade incometax,  undervalued  his securities.    The  High  Court,  therefore,  answered   the question  in  the  affirmative.   The  present  appeals  are against this judgment of the High Court. It  seems  to  us that the decision of  the  High  Court  is clearly  erroneous.  Under r. 2 of the Schedule the  Income- tax  Officer has to compute the profits and gains of a  life insurance  company  at  the greater of the  two  methods  of assessments mentioned in cls. (a) and (b).  There may be  no restriction  upon  his jurisdiction in  the  computation  of profits  and  gains  under cl. (a) but  under  cl.  (b)  the computation  can be made within a limited field.  He has  to accept  the annual average of the surplus disclosed  by  the actuarial  valuation  made  in  accordance  with  the   Life Insurance Act in respect of the last intervaluation  period, so  as to exclude therefrom any surplus or deficit  included therein  which  was  made  in  the  earlier  inter-valuation period,  and  expenditure  not  allowable  under  s.  10  in computing the profits.  This is made explicit by r. 3  which makes it obligatory 886 upon  the Income-tax Officer to make the computation of  the surplus  for  the purpose of r. 2 according  to  the  scheme provided in cls. (a), (b) and (c) of r. 3. Under r. 2(b)  of the Schedule the Income-tax Officer has, therefore, no power to  change the figures in the account of the  assessee.   He has  to  take  the surplus as  disclosed  by  the  actuarial valuation  made by the assessee under the Insurance Act  and then to arrive at the average mentioned in the rule. lie has the power to exclude any surplus or deficit included in  the actuarial valuation in respect of an earlier inter-valuation period  and any expenditure other than an expenditure  which may under s. 10 of the Act be allowed.  What the  Income-tax

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Officer  in  the present case did does not  come  within  r. 2(b).  This is not disputed. It  is  furthermore  not  in dispute  that  apart  from  the provisions in r. 3 of which only cl. (b) is relevant for our purpose,  there is no other provision in the Schedule  which authorises  an Income-Tax Officer to make adjustments in  the actuarial  valuation made by the assessee.  When we come  to r. 3(b) we find that the first part of it lays down that  it shall  be  obligatory  on the Income-tax  Officer  to  allow certain amounts written off or reserved by the assessee as a deduction  and to include in the surplus any sums for  which credit has been taken on account of appreciation or gains on the  realisation  of the securities or other  assets.   This part  of  the rule only compels the  Income-tax  Officer  to allow  certain amounts as deductions and to include  certain amounts  for which credit had been taken in the accounts  of the  assessee.   It, therefore, does not  warrant  what  the income-tax  Officer did, namely, to adjust the  accounts  on the basis of a revaluation made by him. Then we come to the proviso in r. 3(b).  It says that if  it appears  to the Income-tax Officer having regard to  certain matters  to  which  it is not necessary  to  refer  here  in detail,  that the rate of interest or other factor  employed in  determining  the  liability in  respect  of  outstanding policies  is materially inconsistent with the  valuation  of the securities and other assets so 887 as  artificially to reduce the surplus, then he  would  have the  power  to make certain adjustments  after  consultation with  the  Controller  of  Insurance.   Quite  clearly   the adjustment  made  in  the present  case  by  the  Income-tax Officer was not of the variety mentioned in the proviso.  He does  not say that he made the adjustment because  he  found that  any  rate  of  interest  was  inconsistent  with   the valuation  of  securities or other assets.   The  adjustment made by him had nothing to do with any rate of interest.  It was  made  only because he thought that the  securities  had been  undervalued.   This he had no power to  do  under  the proviso.  This again is not in dispute. The result, therefore, is that we find nothing in the  rules justifying the adjustment made by the Income-tax Officer  in the present cases.  We have set out the relevant  provisions and  we  think  that  they  do  not  contemplate  any  other adjustment  of the figures in the accounts of the  insurance companies  apart from what they expressly provide  for.   We have shown that the present adjustment does not fall  within those so expressly provided for. The  only  other question is, Is there a  general  right  to correct  the errors in the accounts of an insurance  company when assessing the income-tax?  The High Court thought there was.   We  are wholly unable to agree with this  view.   The assessment  of  the  profits of  an  insurance  business  is completely  governed by the rules in the Schedule and  there is no power to do anything not contained in it.  The  reason may be that the accounts of an insurance business are  fully controlled  by  the.   Controller  of  Insurance  under  the provisions  of the Insurance Act.  They are checked by  him. He has power to see that various provisions of the Insurance Act are complied with by an insurer so that the persons  who have   insured   with  it  are  not  made   to   suffer   by mismanagement.  A tampering with the accounts of an  insurer by an Income-Tax Officer may seriously affect the working  of the insurance companies.  But apart from this considera- 888 tion, we feel no doubt that the language of s. 10(7) and the

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Schedule  to the Income-tax Act makes it  perfectly  certain that  the Income-tax Officer could not make  the  adjustment that he did in these cases. It  may  be  pointed  out that  the  question  referred  was confined  to the powers of the Income-tax Officer  under  r. 3(b)  of  the  Schedule.  Indeed  learned  counsel  for  the assessee  did not contend to the contrary.  The High  Court, as  may have been noticed, held that the proviso to r.  3(b) was not intended to cover cases like the present.  It  would appear,  therefore,  that the High Court  thought  that  the Income-tax  Officer had no power under the rule to make  the adjustment.  It however none the less answered the  question in  the affirmative.  Obviously what was meant was that  the Income-tax Office.- had the power quite apart from the rule, to make all adjustments to prevent evasion of tax.  The High Court  in fact expressly said that the rule did not  deprive the Income-tax Officer of the power to do this.  It is clear that. the High Court had travelled beyond the question.   No objection having been taken at the bar to this procedure, we have  dealt  with the matter from this point of  view  also. The question framed has to be answered in the negative. We would for this reason allow the appeals with costs. HIDAYATULLAH  J.-  I  agree  but  would  like  to  add   the following. These  are three appeals by certificate granted by the  High Court of Punjab under s. 66(A) of the Income-tax Act against its judgment dated March 2, 1960.  The appellant is the Life Insurance Corporation (Unit: Bharat Insurance Company  Ltd.- original appellant).  The appeals relate to assessment years 1952-53,  1953-54, and 1954-55, and the corresponding  years of account were the calendar years 1951, 1952 and 1953.  The assessment  was  made  on  the  original  appellant   Bharat Insurance  Co.,  Ltd. by the Income-tax  Officer,  Companies Circle, New Delhi under the rules framed for assess- 889 ment of insurance companies pursuant to s. 10 sub-s. (7)  of the  Income-tax Act, on the basis of the annual  average  of the  surplus of the insurance company as found by  actuarial valuation  in the last intervaluation period of  four  years ending  on December 31, 1951 and accepted by the  Controller of  Insurance  under  the  Insurance  Act,  1938.   In  this quadrennium,  the Bharat Insurance Co., Ltd. had  debited  a sum  of  Rs. 18,75,000 in the consolidated  revenue  account from   January  1,  1948  to  December  31,  1951  and   had transferred the same to the investment reserve fund to  meet an  alleged  depreciation  in the  value  of  securities.The Income-tax  Officer compared the book value and  the  market value of the stocks and shares and found that that insurance company  had under-valued certain shares and  securities  by Rs. 1,58,756 in the aggregate, and increased the  investment reserve fund by a sum of Rs. 30,420 which was not  required. The  Income-tax  Officer disallowed Rs.  1,75,000  from  the total amount of Rs. 1,89,186 and added it to the surplus for calculating  tax.   He  held at the same time  that  in  his opinion  the balance left over "provided adequate  cover  as contemplated by rule 3(b) of the rules under s. 10(7) of the Insurance   Act."   On  appeal,  the   Appellate   Assistant Commissioner  reduced  the  figure of Rs.  1,89,186  to  Rs. 1,61,770.  He also reduced the amount of Rs. 1,75,000 to Rs. 1,45,000.   With  this modification (among some  others)  he dismissed  the appeal.  Against the order of  the  Appellate Assistant  Commissioner appeals were filed  respectively  by the  Income-Tax Officer, Companies Circle (1),  New  Delhi-1 and  the  Bharat Insurance Co., Ltd.  There  were  thus  six appeals  in  respect  of the three  assessment  years.   The

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Tribunal  held  by  its  order dated  October  23,  1956  as follows:               "The Income-tax Officer objects to the  relief               given by the Appellate Assistant  Commissioner               while the assessee objects to the  adjustments               which  were made by the Income-tax Officer  in               toto.   The  proviso  to  Rule  3(b)  of   the               Schedule  appended  to Section  10(7)               clearly lays down that 890               the  Income-tax  Officer has  to  consult  the               Controller  of  Insurance  before  he  becomes               competent  to  make  any  adjustments  to  the               actuarial surplus disclosed by the  valuation.               In   this  case  no  consultation   with   the               Controller  of Insurance appears to have  been               made.  The adjustments made by the  Income-tax               Officer  on this account are,  therefore,  set               aside.   The  assessments  will  be   modified               accordingly. The  Commissioner  of Income-tax Delhi  and  Rajasthan  then moved  the  Tribunal  for  a reference  to  the  High  Court suggesting for decision the question:               "Whether the proviso to Rule 3(b), Schedule to               Indian Income-tax Act, 1922 was applicable and               whether  the Income-tax Officer was  bound  to               consult  the Controller of Insurance  in  this               case where no question arose about the rate of               interest  or other factor employed  in  deter-               mining the liability in respect of outstanding               policies ?" The  Tribunal drew up a consolidated statement of  the  case for  the three assessment years and referred  the  following question for the decision of the High Court:               " Whether upon the facts found by the Tribunal               the  Income-tax  Officer  had  in  this   case               jurisdiction to proceed to make adjustments in               terms  of  Rule 3(b) of the  Schedule  to  the               Indian Income-Tax Act?" In  the  High Court, the Commissioner  made  an  application under s. 66(2) of the Income-tax Act for an order  directing the  Tribunal  to  refer  the  former  question;  but   that application was disposed of alongwith the reference and  the High  Court  by its order under appeal answered  the  latter question against the assessee and dismissed the  application under  s.  66(2) of the Income-tax Act.  Khosla,  C.J.  and. Grover,’  J. who disposed of the above  reference,  observed that the question which they were answering comprehended the other question.  The High Court in disposing 891 of  The reference held that the Income-tax Officer  had  the jurisdiction "to deal with the matter in the manner employed by  him" and "was not obliged to consult the  Controller  of Insurance   before  he  corrected  the  valuation   of   the securities".   It may be mentioned that while the  reference was  pending  in the High Court a  Government  Administrator took over the insurance company.  Subsequently, the Life In- surance  Corporation,  by virtue of a  notification  of  the Government  of  India  under s. 45  of  the  Life  Insurance Corporation  Act,  1956,  took over from July  6,  1960  the assets  and liabilities of the insurance company in  respect of  the  controlled business as defined in s.  2(3)  of  the Corporation Act.  The Corporation, in the circumstances, was substituted  as  the  appellant in place  of  the  insurance company  under s. 9 of the Life Insurance  Corporation  Act.

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In  this appeal, it is contended that the High Court was  in error  in  the conclusion it reached and the answer  to  the question  should have been in favour of the  Life  Insurance Corporation and against the Department. Before  dealing with this case, a reference in brief to  the scheme of the Insurance Act and to the rules framed under s. 10(7)  of the.  Income-tax Act for assessment  of  insurance companies  is  necessary.  By s. II of  the  Insurance  Act, every insurer in India and every foreign insurer in  respect of  the  insurance business transacted by him  in  India  is required to prepare at the expiration of each calendar  year with  reference  to  that year (a) a balance  sheet,  (b)  a profit and loss account and (c) a revenue account.   Special forms are prescribed and the schedules to the Act provide by Regulations  what  should be shown in these  accounts.   The balance  sheet,  profit and loss  account,  revenue  account including  accounts which the other provisions  require  the insurer to prepare, must then be audited by an auditor.   By s.   13  of  the Insurance Act, every insurer,  carrying  on life  insurance business, is required, at intervals  of  not less than 3 years, to cause an actuarial investi- 892 gation  to  be  made into the financial  condition  of  life insurance business carried on by him, including a  valuation of  its  liabilities  in  respect  of  that  business.   ’An abstract of the report of the actuary must then be  prepared according to prescribed regulations.  These accounts and the abstract,  together  with  other  statements  etc.  must  be submitted  to the Controller of Insurance.   The  Controller may ask for further information and, if he so desires,  take evidence  and order a re-valuation causing at the same  time an  investigation  to be made.  The  Insurance  Act  further requires  that  every insurer must invest and at  all  times keep  invested,  assets  equivalent to  the  liabilities  on matured  claims  or  on the policies in  the  life  business maturing  for  payment.  Sections 27 and  27A  indicate  the kinds  of  investments in which the insurer must  invest  or keep invested the assets and the controlled fund. The balance sheet of life insurance business must always  be prepared  as  a separate document.  The  regulations  enjoin that a statement in Form AA showing the market value and the book  value of the assets in India must be appended  to  the balance  sheet.  The accounts must be signed  and  certified and in particular, a certificate must be appended explaining how  the  values  as  shown in  the  balance  sheet  of  the investment of stocks and shares have been arrived at and how the  market  value  thereof has  been  ascertained  for  the purpose  of comparison with the values so shown.  There  has further to be another certificate that the items in  respect of reversions and life interests have been valued as on  the date of the balance sheet by an actuary and the assets shown under  the  heading "investments" have not  been  valued  at amounts  exceeding  the realisable or  market  value.   This precaution is necessary otherwise there may not be  adequate cover for the liabilities.  For this purpose, Form AA  which has  to  be  annexed  to  the  balance  sheet  must  show  a classified summary of the assets on the date of the  balance sheet and it must show in particular: 893               (a)   the  value for which credit is taken  in               the  balance  sheet  for each  of  the  above-               mentioned classes of assets;               (b)   the  market value of such of the  above-               mentioned classes of assets as has been ascer-               tained from published quotations after  deduc-

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             tion  of accrued interest included  in  market               prices in those cases where accrued interest               is included elsewhere in the balancesheet;               (c)   how  the  value of such  of  the  above-               mentioned  classes of assets as has  not  been               ascertained from published quotations has been               arrived at. The  revenue  account has to be prepared in  four  forms  of which  Form D shows the revenue account applicable  to  life insurance  business  in respect of the year  and  the  other three  documents are statements of life  insurance  policies for the same year (Form DD), the additions to and deductions from  policies  (Form  DDD)  and  particulars  of   policies forfeited or lapsed in the year (Form DDDD) The  Regulations for  the  preparation of the abstract of the report  of  the actuary  are  to  be found in the  fourth  schedule  to  the Insurance  Act.  This schedule is in two parts.  The  second part lays down inter alia that every abstract shall show the average  rates  of interest yielded by the  assets,  whether invested or uninvested, constituting the life insurance fund for  each of the years covered by the valuation  period  and Regulation  3  of Part 1 lays down how the average  rate  of interest yielded in any year by the assets constituting  the life   insurance  fund  must  be  calculated.   This  is   a complicated calculation which it is unnecessary to  describe here.   The  abstracts must explain the specific  manner  in which the said average rate of interest has been calculated. The  consolidated revenue account has to be shown in Form  G and  a  final  valuation balance sheet  is  required  to  be prepared  in Form 1 which compares the net  liability  under business  as  shown  in the summary  and  valuation  of  the policies on the one hand with 894 the  balance of life insurance fund as shown in the  balance sheet  on  the other and this discloses the surplus  or  the deficiency  as the case may be.  As investments  depreciate, an  investment reserve fund is maintained to  which  amounts are transferred to make up for the shortfall.  The Insurance company  is  thus  required to maintain  an  insurance  fund sufficient  to  cover  its liabilities  in  investments  and depreciation  in  the  value  of  the  investments  must  be specially provided for by making other investments which are kept  in  the  investment reserve fund.  We  are  now  in  a position to understand the provisions of the Income-tax  Act which include references to these documents. To  begin  with,  it  must  be  remembered  that   insurance companies  are  assessed  somewhat  differently  from  other business  organisations.  Normally sections 8, 9, 10 and  12 of  the Income-tax Act apply to the assessment  of  business organisations  but  the rules for  assessment  contained  in those  sections  do  not  apply  to  the  assessment  of  an insurance  company.  Section 10 of the Income-tax Act  deals with  the head  " profits and gains of business &  c.". Sub- section  7, however, says that notwithstanding  anything  to the  contrary  contained  in ss. 8, 9, 10,  12  or  18,  the profits  and gains of any business of insurance and the  tax payable  thereon  shall be computed in accordance  with  the rules  contained  in a schedule to, the  Act.   These  rules provide the mode of computing the profits and gains of  life insurance  business.  Under r. 2, the profits and  gains  of life insurance business are taken to be either-               "(a) the gross external incomings of the  pre-               ceding  year  from  that  business  less   the               management expenses of that year, or               (b)   the   annual  average  of  the   surplus

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             arrived at by adjusting the surplus or deficit               disclosed  by the actuarial valuation made  in               accordance with the Insurance Act, 1938 (IV of               1938), in respect of the last 895               inter-valuation period ending before the  year               for  which the assessment is to be made so  as               to  exclude  from it any  surplus  or  deficit               included therein which was made in any earlier               inter-valuation  period  and  any  expenditure               other  than  expenditure which may  under  the               provisions  of  section  10  of  this  Act  be               allowed for in computing the profits and gains               of a business, whichever is greater:"               x          x           x           x In this case the second method was applicable.  Rule 3  (,in so  far as it is relevant for our purpose) then provides  as follows:               (a) x         x          x        x     x               (b)     any  amount  either  written  off   or               reserved  in  the  accounts  or  through   the               actuarial  valuation  balance  sheet  to  meet               depreciation of or loss on the realisation  of               securities or other assets shall be allowed as               a deduction, and any sums taken credit for  in               the  accounts or actuarial  valuation  balance               sheet  on account of appreciation of or  gains               on the realisation of the securities or  other               assets shall be included in the surplus:               Provided that if upon investigation it appears               to  the Income-tax Officer after  consultation               with  the Controller of Insurance that  having               due   regard  to  the  necessity   to   making               reasonable    provision   for    bonuses    to               participating  policy-holders  and  for   con-               tingencies,  the  rate of  interest  or  other               factor  employed in determining the  liability               in   respect   of  outstanding   policies   is               materially inconsistent with the valuation  of               the   securities  and  other  assets   so   as               artificially  to  reduce  the  surplus,   such               adjustment shall be made to the allowance  for               depreciation of,. or to the amount to be 896               included  in the surplus in respect of  appre-               ciation of, such securities and other  assets,               as shall increase the surplus for the purposes               of  these rules to a figure which is fair  and               just;                x      x      x         x                   x Rule 2 shows what shall be taken to be the profits and gains of the insurance company.  Rule 3 shows what changes can  be made  in the annual average of the surplus.  The purport  of Rule  3, in the context of this case, may now be  stated  in simple language.  It provides in its main part that  amounts reserved in the accounts or through the actuarial  valuation balance-sheet  to meet depreciation of securities  shall  be allowed as a deduction and ex converso any sums taken credit for in the accounts or actuarial valuation balance-sheets on account  of appreciation of securities shall be included  in the  surplus.   In short, the amount by which the  value  of securities  depreciates is allowed as a deduction  from  the surplus  and  the amount of appreciation  of  securities  is included  in  the  surplus.  There is no  question  here  of appreciation  and  the  latter part of the  main  rule  may,

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therefore, be ignored.  This case is concerned only with the depreciation  of the securities in the reserves as shown  in the  accounts and through the actuarial  valuation  balance- sheets.   If  such depreciation in fact takes place,  it  is open to the insurance company to claim that it be allowed as a deduction from the surplus and it must be allowed.  But by undervaluing  the stocks and shares, it is  always  possible artificially to reduce the surplus by making a part of it go into  the reserve to take the place of the amount  by  which the  stocks and shares are alleged to have, but have not  in fact, depreciated.  The proviso which is annexed to the main rule  takes note of the existence of such a possibility  and provides  that  if the Income-tax Officer  on  investigation finds  (after consultation with the Controller of  Insurance that   the  rate  of  interest  or  other  factor   employed determining the liability in respect of outstanding policies is  materially  inconsistent  with  the  valuation  of   the securities and other assets so as artificially 897 to  reduce the surplus, he may make such adjustments to  the allowance for depreciation as shall increase the surplus  to a  figure which is fair and just.  The proviso further  says that  in  doing  so  the  necessity  for  making  reasonable provision  for bonuses to participating  policy-holders  and for contingencies must be taken into consideration.  Put  in simple  language, it means that the Income-tax Officer  can, after investigation and consultation with the Controller  of Insurance,  increase the surplus to a figure which  is  fair and  just.   But  this action is Open to  him  only  if  the valuation  of  the  securities and  other  assets  has  been artificially manipulated to reduce the surplus by making the rate of interest or other factor employed in determining the liability  in respect of outstanding  policies  inconsistent with the valuation of the securities.  Further, the  Income- tax  Officer,  before  he makes any  change,  must  pay  due attention  to the necessity for making reasonable  provision for    bonuses   to   participating    policy-holders    and contingencies. The power which is conferred on the Income-Tax Officer  under the proviso clearly has its limitations, and is hedged in by conditions-.   In the present case, the  Income-tax  Officer admittedly did not consult the Controller of Insurance.  Nor did   he  consider  the  necessity  for  making   reasonable provision  for bonuses to participating  policy-holders  and for  contingencies.  Nor did he establish that the  rate  of interest  or  other  factor  employed  in  determining   the liability in respect of outstanding policies was  materially inconsistent  with the valuation of the securities or  other assets.   What he did was to’ find out the market  value  of stocks  and  shares  and  to compare  that  value  with  the valuation actually made and on finding that they were under- valued,  to  add  a certain amount to the  surplus  for  tax purposes.   The  Appellate Assistant  Commissioner  differed about the market value of the stocks and shares and  reduced the  amount which was added but did no more.  The  Tribunal, which  reversed these orders, went merely by the failure  of the Income-tax Officer to consult 1/SCI/64-57 898 the  Controller  of  Insurance.   The  two  questions  (that proposed  by  the Commissioner and that  actually  referred) bring into relief respectively the actions of the Income-tax Officer  and  the order of the Tribunal.   The  question  as answered  refers to the Income-tax Officer’s decision  while the  other  was  limited  to  the  Tribunal’s  order.    The

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Department did not seek to place its case under the  proviso either before the High Court or before us, perhaps,  because the conditions in the proviso (whether they be directory  or mandatory),  bad not been followed at all.   The  Department claimed that the matter fell to be governed by the main rule without  the assistance of the proviso and  this  contention appears to have been accepted by the High Court. As has been shown above, Form G is the consolidated  revenue account.   The  Bharat  Insurance Company  had,  during  the quadrennium  commencing  on January 1, 1948  and  ending  on December  31,  1951, transferred to the  investment  reserve fund  a  sum of Rs. 18,75,000 and shown it in  Form  G.  The balance  of life fund thus stood at Rs. 5,45,88,286-1-10  as against the net liability of Rs. 5,19,42,924 and there was a surplus.   The  valuation  balance-sheet in  Form  1  as  on December 31, 1951 thus was:                        Rs.                              Rs.      Net liability               Balance of Life      under business              Assurance Fund      as shown in the             as shown in the      summary and                 Balance sheet   5,45,88,286      valuation      5,19,42,924      Surplus          26,45,362                    -------------                ------------                     5,45,88,286                  5,45,88,286 The  valuation abstract prepared under the  fourth  schedule showed that the actuary had. assumed the rate of-.  interest at  3  %  per annum and he found that the  average  rate  of interest  earned on the mean life fund in each year  was  as follows: 899 Year ending 31st December, 1948            3.5 per cent.     "        "        "    1949             3.27   "     "        "        "    1950            3.27   "     "        "        "    1951            3.26   " The Income-tax Officer did not concern himself with the rate of interest employed in determining the liability in respect of  outstanding  policies.  He considered the  valuation  of stocks  and  shares  held in the life fund with  a  view  to ascertaining whether the sum of Rs. 18,75,000 transferred to the   investment   reserve  fund  to  balance   an   alleged depreciation in the value of stocks and shares was justified or  not.   He examined for this purpose the details  of  the alleged  depreciation amounting to Rs. 22,64,733  which  had been  worked out by the assessee company and  observed  that after  the  transfer  of Rs.  18,75,000  to  the  investment reserve  fund the balance to the credit of the fund was  Rs. 22,95,154 when it need not have been more than Rs. 22,64,733 and  this  showed an excess of Rs. 30,420.  This  excess  he disallowed.  He then found out the market rate of stocks and shares  in the fund and came to the conclusion that some  of these  were under-valued by a sum of Rs. 1,58,756.  He  held that  an  excess  of Rs. 1,89,186  was  transferred  to  the investment reserve fund from the surplus.  According to him, the surplus of Rs. 26,45,362 shown in Form 1 required to  be adjusted  and  he added a lump sum of Rs.  1,75,000  to  the surplus.   In  other words, the total  depreciation  claimed under  Rule 3(b) as an allowance was not accepted.  The  sum of  Rs.  1,75,000  was reduced by  the  Appellate  Assistant Commissioner to Rs. 1,45,000 and it was altogether cancelled by the Income-tax Appellate Tribunal. The  learned Judges of the High Court in dealing  with  this matter  observed  that the excess of Rs. 30,420 was  not  an actual depreciation and no provision need have been made  in the  reserve  fund for this sum.  They also  held  that  the

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Income-tax Officer had rightly held that some of the  stocks and   shares  had  been  deliberately  under-valued.    They accepted the proposition that the making of an adjustment in the 900 surplus  on  a finding that the rate of  interest  or  other factor  employed in determining the liability in respect  of outstanding   policies  and  other  assets  was   materially inconsistent with the valuation of the securities and  other assets, and the making of adequate provision for bonuses  to participating policy-holders and contingencies was a  matter for a specialist and that the Income-tax Officer, if he made an  adjustment, should procure the advice of the  Controller of  Insurance before making any change on the basis  of  his own  knowledge.  But they held that the proper valuation  of the  securities  did not require a specialist and  that  any person  could get market quotations and find out, the  value of  the  securities.   According  to  the  learned   Judges, although  the proviso enjoined upon the  Income-tax  Officer the duty to consult the Controller of Insurance and also  to make adjustments in a particular way, the main rule  allowed the  Income-tax  Officer to fix the amounts  of  permissible deductions  on  the  basis of a  correct  valuation  of  the securities and the Income-tax Officer’s jurisdiction in this respect  was not in any way controlled. ,According to  them, the  fixing of the correct value of the assets was  not  the sort  of adjustment which was contemplated by  the  proviso; therefore, neither was prior consultation necessary nor were the  conditions  precedent  as  laid  down  in  the  proviso applicable.   They  referred to the decision of  the  Bombay High  Court in Western India Life Insurance Co. Ltd.  In  re (1)  and  observed’ that such action  was  held  permissible under rule 30 of the superseded rules which they held was in pari materia with the main rule 3(b), and to the decision in Commissioner  of  Income-Tax, Bombay, Sind and  Rajasthan  v. Indian  Life Assitrance Co. Ltd, (2) in which the dictum  of the  High Court was applied by the Sind Chief  Court.   They concluded:               "It is therefore, clear that the proviso  does               not  apply  to. a case  where  the  Income-tax               Officer has to see whether the securities have               been correctly               (1) [1938] VI I. T. R. 44.                (2) [1946] XIV I. T. R. 347. 901               valued  or  not.   He  must  satisfy   himself               without  any  reference to the  Controller  of               Insurance that the securities which are  being               transferred  to the reserve fund are  no  more               than  necessary to meet depreciation  or  loss               that  has  actually  been  suffered,  and   to               determine  this  he  must  have  the   correct               valuation of the securities." In  the  result, they held that the Income-tax  Officer  had "full  jurisdiction" to deal with the matter in  the  manner employed by him. Mr.  Setalvad  on behalf of the Life  Insurance  Corporation pointed  out that the actuarial valuation  balance-sheet  in Form 1 had determined the surplus by deducting from the Life Insurance  fund as on the valuation date the  net  liability under  the life insurance business.  He pointed out that  in working out this liability the actuary had assumed the  rate of interest at 3 % per annum and to arrive at this figure he had taken into consideration the average interest yield  for the four years covered by the valuation.  The interest yield

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thus  was obtained by properly following the procedure  laid down by Regulation 3 of Part 1 of the fourth schedule to the Insurance Act.  He contended that if the interest yield were found  to be lower by reason of the reduction of the  amount of depreciation, the liability for the policies, as calcula- ted  in the accounts, would be disturbed and  the  liability would increase.  He pointed out that Rule 30 of the previous rules  was amended by the addition of a proviso in  the  new Rule 3(b) to make it incumbent that an adjustment in respect of depreciation of securities in the actuarial balance sheet should only be made after complying with certain conditions. ’-He  contended  that action could only be taken  under  the proviso  and  in  accordance  with  its  strict  terms.   He submitted that by merely reducing the amounts transferred to the investment reserve fund the Income-tax Officer could not increase the surplus, for in doing so, he reduced the  cover and  thus  seriously disturbed the provision  for  liability under  the  policies  and  the  provision  for  bonuses   to participating policy-holders 902 and  contingencies,  and that such action of  the  Income-Tax Officer was without jurisdiction. On behalf of the Department, Mr. Gopal Singh contended  that there was a general power in the Income-tax Officer  derived from  the main rule 3(b) and independent of the  proviso  to make such an adjustment.  Mr. Gopal Singh did not rely  upon the proviso and contended that the Income-tax Officer  could find out from the market quotations the value of stocks  and shares   and  if  he  found  a  disparity,  he  could   make adjustments  by  refusing to allow the deduction  which  was claimed  under  rule  3(b).  According to him,  it  was  not necessary  to  go to the proviso at all and  in  any  event, consultation  with  the  Controller  of  Insurance  was  not absolutely  necessary  and  what  he  did  was  within   his jurisdiction.  He submitted that the Income-tax Officer  had jurisdiction to decide what was just and proper and had done so  under his general power flowing from the main rule  3(b) without the aid of the proviso. It  is clear that the Income-tax Act contemplates  that  the assessment of insurance companies should be carried out  not according to the ordinary principles applicable to  business concerns  as  laid down in s. 10, but in quite  a  different manner.  Insurance companies do not compute their profits in the ordinary way because premiums cover risks which run into future  years and loss includes losses from previous  years. The method prescribed ensures that by taking the average  of several  years a fair and reasonable conclusion is  reached. Actuarial  estimation  plays an important part  and  surplus only  results when there is an excess of the fund  over  the liability after all other charges are met.  The rules  which have   been  quoted  lay  down  two  different  methods   of ascertaining  profits.  Rule 2(a) merely compares the  gross external incomings of the preceding year with the management expenses.Rule  2(b) contemplates the annual average  of  the surplus or deficit disclosed by actuarial valuation. In the present case the first limb of rule 2 did not  apply. So the annual average of the surplus 903 found by the actuary had to be taken and from it the surplus of  the  last inter-valuation period had to be  deducted  as also  expenditure  allowable under s. 10 of  the  Income-tax Act.  This is the basic calculation and they were  followed. Certain special limitations indicated in the proviso to rule 2  and  rule  3(a) are not relevant for  the  present  case. Under the main part of rule 3(b) certain special  deductions

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and  additions  must be made to the annual  average  of  the surplus  determined under the second rule.  Since  the  life fund  is  held  in securities and the price  of  stocks  and shares  fluctuates, provision has been made in rule 3(b)  to make  adjustments.   Rule 3(b) in its main  part  speaks  of adjustments  on  the basis of the accounts  and  amounts  as entered  in the accounts determine what must be added to  or deducted  from  the surplus.  The  Income-tax  Officer  must deduct  from the annual average of the surplus for  purposes of  rule  2  any amount entered in  the  accounts  to  cover depreciation of the securities and assets and add any amount taken credit for on account of appreciation.  The Income-tax Officer  here follows the accounts and gives effect  to  the entries  such as they are.  The provision is  mandatory  and the Income-tax Officer has no discretion. If  the Income-tax Officer doubts the accounts,  his  powers are  defined  by the proviso.  Rule 3(b)  which  allows  the Income-tax   Officer  to deduct from or add to  the  surplus amounts   shown  in  the  accounts  for   depreciation   and appreciation  of  securities as the case may  be,  does  not confer  on him a power to disturb the annual average of  the surplus  at his sweet will.  No doubt, the perception  of  a -discrepancy  between what is entered in the  accounts  and’ what  is fact, is not something which is or can be made  the subject of rules.  Rules can only provide how the Income-tax Officer   must  proceed  in  the  matter  if  he  finds   an inaccuracy.   The entire subject of such  disparity  between fact and actual entries is comprehended in the proviso.   If the  Income-tax Officer accepts the accounts he must  reduce or increase the 904 surplus  by the amounts actually shown for  depreciation  or appreciation  in  the accounts.  His powers under  the  main rule  end  there.   If he discovers a  discrepancy  (not  de minimis)  he  must proceed under the proviso.   The  proviso requires  him to consult the Controller of Insurance and  to bear  in mind that reasonable provision has to be  made  for bonuses    to   participating   policy-holders    and    for contingencies,  and  he  can  act only  where  the  rate  of interest  or  other  factor  employed  in  determining   the liability  under the policies materially  inconsistent  with the  valuation  of  securities  and  this  results  in   the artificial  reduction of the surplus.  It is clear that  the proviso negatives the existence of a separate general power. Action  has  to  be taken in the manner  laid  down  in  the proviso or not at all. In  the present case, the Income-tax Officer did not  follow the  proviso at all.  The Department did not rely  upon  the proviso in the High Court and even before us did not seek to justify the action of the Income-tax Officer with  reference to the proviso.  No doubt, an attempt was made before us  to limit  the  generality of the question debated in  the  High Court  to  the specific point decided by  the  Tribunal  and outlined in the question suggested by the assessee.  But the gist  of the matter is the same whichever way one  looks  at it.   The  adjustment  of  the  surplus  in  the  matter  of appreciation and depreciation of securities not on the basis of the accounts but on the basis of the Income-tax Officer’s discretion  can only be done in the manner laid down in  the proviso.   Such power is not available under the  main  rule which  merely  allows  book entries to be  worked  into  the surplus. I  find it impossible to endorse the view of the High  Court that  the Income-tax Officer had any general power  to  make adjustments  independently of the proviso.  If  he  detected

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any  discrepancy  he had to proceed under the  proviso.   To hold  otherwise would make the proviso  entirely  redundant, and it is quite clear that such could not be the intention. 905 Cases  under the former rule 30 cannot be used a  precedents because the present rule 3(b) has bee materially altered  by the addition of the proviso Formerly the rule tried to serve both  the objects busing the word "may" but the  word  "may" which gave a discretion to the Income-tax Officer could lead to  arbitrary actions and the rule is now in two parts,  the main rule leaving no discretion and the proviso conferring a power subject to certain conditions. In the result, I disagree with the High Court in the  answer which it gave to the question.  The proper answer was in the negative.   I agree, therefore that the appeals  be  allowed with costs on the respondent here and in the High Court. Appeals allowed.