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PETITIONER: PANDHYAN INSURANCE CO.  LTD.

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX, MADRAS

DATE OF JUDGMENT: 29/09/1964

BENCH: SIKRI, S.M. BENCH: SIKRI, S.M. SUBBARAO, K. SHAH, J.C.

CITATION:  1965 AIR 1004            1965 SCR  (1) 367  CITATOR INFO :  R          1965 SC1902  (17)

ACT: Income Tax Act (11 of 1922) Schedule, rr. 3(b) and  6--Scope of

HEADNOTE:  The  appellant  (assessee) was a company  carrying  on  the business  of  general insurance.  It erected  a  substantial modem building at a cost of about Rs. 12,00,000 towards  the end  of 1952.  For the accounting year 1953 it wrote  off  a sum  of about Rs. 1,00,000 as representing the  depreciation with  respect  to. various items.   The  Income-tax  Officer disallowed 4/5 of the depreciation on the ground that only a fifth  part of the building was utilised for the purpose  of the appellant’s business and the remaining 4/5 part was  let out,  and that the rent thereon was exempted under  s.  4(3) (xii)  of  the  Income-tax  Act, 1922.   On  appeal  by  the assessee, the Appellate Assistant Commissioner dismissed the appeal  and enhanced the assessment by disallowing even  the 115  of the depreciation allowed by the Income Tax  Officer, on the ground that under r. 3(b) of the Schedule to the Act, the allowable depreciation was an actual depreciation of the value  of  the  assets.  On further  appeal,  the  Appellate Tribunal  restored the order of the Income-tax Officer  with respect  to 115 part but as to the 4/5 part agreed with  the Appellate  Assistant  Commissioner.  The High  Court,  on  a reference  as ’to whether the 4/5 part of  the  depreciation was  also  allowable  as  a  deduction  in  the   assessment completed  under  s. 10(7) and the rules  contained  in  the Schedule, of the Act, held against the appellant.  On appeal to the Supreme Court, HELD : The appeal must be allowed. [374C]. Rules  3(b)  and 6 of the Schedule to  the  income-tax  Act, which  are the applicable rules, should be read against  the background of the various provisions of the Insurance Act (4 of  1938)  making  detailed provision  to  ensure  the  true valuation  of  assets  and the  determination  of  the  true balance  of profits of an insurance business.  So read,  the Income Tax Officer can exclude from the balance of  profits, only  any expenditure which is not allowable under s. 10  of

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the Income-tax Act.  The word "expenditure" inr. 6 means disbursement and does not comprehend depreciation. As regar- ds  "depreciation", it covers both actual and notional,  and the  Income Tax Officer has no option but to allow it  under r. 3 (b). He cannot ask the assessee to prove that there has been  any  actual  depreciation. [370E; 372A,  C;  373E,  F; 374C]. Life  Insurance  Corporation  of India  v.  Commissioner  of Incometax (1964) 51 I.T.R. 773, followed.

JUDGMENT:    CIVIL  APPELLATE JURISDICTION : Civil Appeal No.  816  of 1963. Appeal by special leave from the judgment dated the July  4, 1961,  of  the Madras High Court in case referred No.  4  of 1957. A.V.  Viswanatha Sastri, R. Venkataraman and  R.  Gopala- krishnan, for the appellant. 368 R.Ganapathy  lyer, R. H. Dhebar and R. N.  Sachthey,  for the respondent. The Judgment of the Court was delivered by Sikri  J.  This is an appeal by special  leave  against  the judgment  of the Madras High Court in a case referred to  it under the Indian Income Tax Act, 1922, hereinafter  referred to  as  the Act, answering the question of law  against  the assessee.  The question referred is :               "Whether four-fifth of the sum of Rs. 1,21,245               written  off in the books of the  assessee  as               depreciation  for  the calendar year  1953  is               allowable  as  a deduction in  the  assessment               completed  under section 10(7) and  the  rules               contained  in the schedule of  the  Income-tax               Act." The  facts  relevant  for  answering  the  question  are  as follows.  The assessee is a public limited company  carrying on  the business of general insurance.  It erected  a  modem substantial  building with lifts and air-conditioning  at  a cost  of Rs. 12,08,252 and got it ready for occupation  from December 1, 1952.  In its books for the calendar year  1953, the previous year for assessment year 1954-55, it wrote  off Rs. 1,21,245 as depreciation as follows                               Rate                   Amount                             Per cent             (in rupees) Buildings                   10                      1,06,940 Air conditioning plant      15                         2,973 Lifts                       15                         6,214 Transformers               15                          1,442 Internal Telephone         15                          3,676                                              TOTAL1,21,245 It  was  common  ground  before  the  Income-tax   Appellate Tribunal that one-fifth of the building could be  considered as  occupied  for its own purposes and the  remaining  four- fifth  as  let  out to tenants  for  rent.   The  Income-tax Officer disallowed fourfifth of the depreciation claimed  on the  ground  that  "the rentals  received  from  this  4/5th portion are being shown separately under the head ’Property’ which income in turn has been claimed as ’exempt under s.  4 (3)  (xii).   Had there been no exemption  in  the  property income  there  would have-been a statutory  allowance  which would compensate for depreciation.  The fact that the  whole income  is  exempt  further strengthens  that  no  allowance regarding these portions could be made.

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369 On  appeal, the Appellate Assistant Commissioner  disallowed the  whole claim (including that allowed by  the  Income-tax Officer) on another ground.  He held that the property  fell within the words’other assets’ used in Rule 3 (b) of  the Schedule,  but  what Rule 3 (b) contemplated was  an  actual depreciation of the value of such assets.  As the counsel of the  assessee  admitted before him that the  property  being new, there could be no question of actual depreciation. On  further appeal, the Appellate Tribunal came to the  con- clusion  that the immovable property to the extent of  four- fifths  thereof  was  an investment  held  ’solely  for  the purpose  of earning rent therefrom capable  of  appreciation either nationally or by sale and realisation’, but under r . 6  of the Schedule, the Income-tax Officer has  jurisdiction to  fix  a figure which is fair and  just.   It  accordingly allowed the appeal in part. On a reference being made to it, the High Court held that in computing profits and gains, the Income-tax Officer had  the power to examine the quantum of depreciation either  written off  or  reserved  and to satisfy himself that  it  did  not exceed the amount allowable to meet the depreciation. It is common ground between the parties that by virtue of s. 10(7)  of the Act the profits and gains of any  business  of insurance  have to be computed in accordance with the  rules contained  in the Schedule to the Act, and ss. 8, 9, 10,  12 or  18  have  no application.  Rule 3(b) and r.  6,  on  the interpretation of which the answer to the question  referred to depends, read thus,:               "3. In computing the surplus for the  purposes               of rule 2-               (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 370               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 included in the surplus               in respect of appreciation 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;               6.The profits and gains of any business of               insurance  other than life insurance shall  be               taken  to  be  the  balance  of  the   profits               disclosed  by the annual accounts,  copies  of               which  are required under the  Insurance  Act,               1938  [4  of  1938], to be  furnished  to  the

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             Controller of Insurance, after adjusting  such               balance   so  as  to  exclude  from   it   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.  Profits and  losses  on               the  realisation of investments and  deprecia-               tion   and  appreciation  of  the   value   of               investments shall be dealt with as provided in               rule 3 for the business of life insurance." Mr. Viswanatha Sastri contends that the Insurance Act,  1938 (4  of  1938) makes detailed provisions to ensure  the  true valuation  of  assets  and the  determination  of  the  true balance of profits of an insurance business.  An examination of  various sections of the Insurance Act discloses that  he is  right in this respect.  Section 1 1 requires an  insurer to prepare at the expiration of the calendar year a  balance sheet,  a profit and loss account, and a revenue account  in accordance with the schedules.  Part I of the First Schedule prescribes  regulations  and  Part II gives  forms  for  the preparation  of a balance sheet.  Regulation 6  enjoins  the appending  to the Balance Sheet a statement in Form  AA,  as set out in Part 11 of the First Schedule, showing the market value  and  the book value of the  assets,  including  house property.  This Form AA has three columns; (1) book value as per  (a) below, (2) market value as per (b) below.  and  (3) remarks  as per (c) below-(a) refers to the value for  which credit  is taken; (b) refers to the market value  of  assets which  has been ascertained from public quotations, and  (c) refers  to  bow  the value of the assets  as  has  not  been ascertained from public quotations has been arrived at.  But it is not necessary to show the market values where they are not  less  than the book values, and a certificate  to  that effect is      371 appended  to  the statement. In other words, if  the  market value     is more than the book value, it need not be shown. Theresult    of the above-mentioned provisions is that the statement ofassets    will  show  book  value  of   house property and its marketvalue     unless  the market  value is more. The Second Schedule prescribes the regulations and forms for the  preparation  of  profits  and  loss  account  of   some insurers.   There are two columns in Form ’B’ which need  be mentioned : (1) Depreciation of Investments (not charged  to Reserves   or   any  particular  Fund   or   Account);   (2) Appreciation of Investments (not credited to Reserves or any particular Fund or Account).  The Third Schedule sets  forth the  regulations and forms for the preparation of a  revenue account  (one of the items to be shown in Form D  is  ’Rents for  offices  belonging to and occupied  by  the  Insurer’). Form  F  is  form for Revenue  Account  applicable  to  Fire Insurance  Business, Marine Insurance Business, and  Miscel- laneous Insurance Business.  One of the items to be shown is " expenses of management" and note (c) says that if any  sum has  been deducted from this item and entered on the  assets side of the Balance Sheet, the amount to be deducted must be shown separately. After the balance sheet, profit and loss account and revenue account  have been prepared, they have to be audited  unless they are subject to an audit under the Indian Companies Act. Under s.  15  the  audited  accounts  and  statements  above referred to have to be   furnished  to  the  Controller   as returns. Section  18  requires  every  insurer  to  furnish  to   the

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Controller  a certified copy of every report on the  affairs of  the concern which is submitted to the members or  policy holders of the insurer. Section  21  enables  the Controller  to  get  such  further information from the insurer as he may consider necessary to correct  or  supplement  a  return,  to  examine  books   of accounts, registers and documents or to examine any officer. The  Controller may decline to accept any return unless  the inaccuracy  has  been corrected or the deficiency  has  been supplied.  If he declines to accept any return, the  insurer shall be deemed to have failed to comply with the provisions of  S.  15,  S.  16  or S. 28 or  S.  28A  relating  to  the furnishing of returns.  Sub-section (2) of S. 21 enables  an insurer to apply to court for cancellation of any order made under  cls.  (a),  (b)  or (c) of  sub-section  (1)  or  for directing the acceptance of any return which the  Controller has declined to accept. 372 above,  should be read in the light of this background.   He says  that  r. 6 authorises an Income-tax  Officer  to  make adjustments  of two kinds.  First, he can exclude  from  the balance  of profits any expenditure which is  not  allowable under S. 10 of the Act.  He says that the depreciation which has been claimed is not an expenditure within r. 6, for  the expenditure  must  be  a disbursement.  He  refers  in  this connection to S. 10(2) (xii), (xiv) and (xv) where the  word I expenditure’ is expressly used.  Coming to the second part of  r.  6, he argues that the word  ’depreciation’  includes both  actual  and  notional depreciation,  and  in  r.  3(b) similarly  the  word  ’depreciation’  includes  actual   and notional depreciation.  If he is right in this, he says that as  r.  3(b)  directs the Income-tax Officer  to  allow  the depreciation,  which  has been written off,  the  Income-tax Officer has no option but to allow it and he cannot ask  the assessee   to   prove  that  there  has  been   any   actual depreciation.   He relies strongly on the decision  of  this Court in Life Insurance Corporation of India v. Commissioner of Income-tax. (1) Let us first see what is the exact  scope of this decision.  Sarkar J., interpreted r.   3 (b) in the following terms :               "When  we come to rule 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."   (emphasis               supplied)               Hidayatullah J.. said this about Rule 3(b);               "Under  the  main part of  rule  3(b)  certain               special deductions 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.

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             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 (1)(1964) 51 I.T.R. 773.  373               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  account  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."               He then adds :               "The entire subject of such disparity  between               fact and actual entries is comprehended in the               proviso." It seems to us that this Court has held in categorical terms that  r.  3(b) does not empower the  Income-tax  Officer  to adjust  the accounts on the basis of a revaluation  made  by him or to correct the discrepancy between what is entered in the accounts and what is fact. Mr.  Ganapathy  Iyer tried to distinguish the  case  on  the ground  that  r. 6 was not applicable to  a  life  insurance business  and was not considered by the Court.  He at  first suggested  that  in  the  second  part  of  r.  6  the  word ’depreciation’ did not include notional depreciation.   When it was pointed out to him that if this is correct, r. 3  (b) would  not  be attracted at all, he modified his  stand  and argued that in r. 3 (b) notional depreciation of property is not  included in the word ’depreciation’.  We are unable  to agree  with  him that the word ’depreciation’ in  r.  3  (b) should  be construed in this limited sense.  The words  "any amount  written  off  ...  in  the  accounts  ...  to   meet depreciation  of ... other assets" have to be understood  in the  ordinary  connotation.   If  the  draftsman  wanted  to include  depreciation on buildings, what Mr. Ganapathy  lyer calls  notional depreciation, he could hardly have used  any other wording. Mr.  Ganajpathy lyer says that this Court in Life  Insurance Corporation  of India v. Commissioner of Income  Tax(1)  did not examine one aspect, and this aspect is derived from  the words  "to  meet" occurring in r. 3 (b).  He says  that  the effect  of  these words is that the  Income-tax  Officer  is obliged to allow any amount written off only if it is really to  meet  actual  depreciation and not  any  other  fanciful conception of depreciation.  This question does not arise on the  facts  of  this case, for once we hold  that  the  word "depreciation" covers notional depreciation, it is (1) [1964151 I.T.R. 773. L2Sup./64-11 374 nobody’s  case that it is not notional depreciation that  is intended to be written off.  There is no sanctity about  the rate of depreciation prescribed under the Act.  If the  rate of depreciation applied by the assessee and accepted by  the Controller  differs  from  that allowed under  the  Act,  it cannot  be  said  that the assessee did not  write  off  the amount to meet depreciation. Mr.  Ganapathy Iyer has referred us to some cases  but  they were discussed in the above-mentioned decision of this Court

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and  there  is no point in discussing them  again.   We  may mention  that  the learned Counsel for the Revenue  has  not rightly urged that the word "expenditure" in the first  part of r. 6 comprehends depreciation.  We agree with Mr.  Sastri that the word "expenditure" in r. 6 means disbursement. Accordingly, we accept the appeal and answer the question in the affirmative.  The respondent will pay costs incurred  in this Court and the High Court. Appeal allowed. 375