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PETITIONER: INDIAN TUBE CO. (P) LTD

       Vs.

RESPONDENT: COMMISSIONER OF INCOME-TAX, CALCUTTA

DATE OF JUDGMENT14/01/1992

BENCH: RAMASWAMY, K. BENCH: RAMASWAMY, K. JEEVAN REDDY, B.P. (J)

CITATION:  1992 SCR  (1)  22        JT 1992 (1)   112  1992 SCALE  (1)26

ACT:      Companies  (Profit) Sur Tax Act, 1964  Sections-2  (b), 4,18-Payment   of   dividend-Recommendation  of   Board   of Directors-Whether   reserve-Whether   to   be   taken   into consideration for computation of capital.

HEADNOTE:      This  appeal  arises out of  proceedings  initiated  to compute the capital of the appellant-company for the purpose of  Sur-tax.  The previous year relevant to  the  assessment year  of  the paid up capital, the reserve,  the  debentures etc.  under Rule 1 of Second Schedule to the Surtax  Act  is the  calendar  year 1963.  The assessment year  is  1964-65. The  position of the capital was to be considered as on  the Ist  day  of January, 1963.  In this connection  it  may  be mentioned  that  the Directors of  the  appellant-assessee’s company  at  their  meeting held on  1.5.1963  approved  the transfer  of a sum Rs. 90,00,000 out of the profits for  the 1962  year to a ‘ Dividend Reserve  Account’, 12 1/2%  which amounted  to  Rs. 76,00,000 on the ordinary  shares  on  the amount  paid  on  those  shares  prior  to  31.12.1962.   On 31.5.1963 in the general meeting the accounts were passed by the  share-holders  and the dividend as recommended  by  the Directors was declared.  Subsequently, the dividend was paid and  it was adjusted by transferring Rs. 76,00,000 from  the dividend  reserve  account  through  the  Profit  and   Loss Appropriation Account.  The question therefore arose whether a sum of Rs.  90,00,000 or any part thereof would be reserve for  computing  the  capital  as  on  January  1,1963.   The appellant  claimed in its assessment a sum of Rs.  90,00,000 transferred  to the dividend reserve as a  reserve  entering into capital computation.  The assessing authority  excluded this  sum from the computation of the capital but  on appeal the  Appellate  Assistant  Commissioner found  it  to  be  a reserve created out of amounts which had not been allowed as deduction  for  computing  the profits  of  that  year.   He therefore  held  that  Rs. 90,00,000 was  the  reserve  fund qualified  for  inclusion under Rule 1 (III) of  the  Second Schedule to the Sur-tax Act.  On appeal by the Revenue,  the Income-tax  Appellate Tribunal held that "the  assessee  had appropriated  Rs.  76,00,000 out of the  Year’s  profit  and transferred  the balance of Rs.  14,00,000 to  the  dividend

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reserve"  :  Rs.  76,00,000 was taken  as  liability  as  on 1.1.1963 and as the creation of Rs. 90,00,000 was                                              23 to  be  taken  as reserve on 1.1.1963, only  a  sum  of  Rs. 14,00,000  has  been  transferred to  the  reserve  account. Accordingly  the Tribunal held that a sum of  Rs.  14,00,000 would only be treated as a reserve and directed modification of  the capital computation.  On a reference  under  section 256(1) of the Income-tax Act and Section 18 of the companies (Profits) Sur-tax Act, 1964 at the behest of the  appellant, the  High  Court answered the question in the  negative  and against  the  assessee.  Hence this  appeal  by  certificate under Section 261 of the Income-Tax Act, 1961.      Dismissing the appeal, this Court,      HELD : A conjoint reading of the scheme of the  Sur-tax Act  and the Company’s Act suggests that  the  appropriation made  by the Board of Directors by recommending  payment  of dividend,  in  the nature of things does  not  constitute  a reserve. [28B]      If  an  amount is satisfied out of  profits  and  other surpluses,   not   to  meet  the   liability,   contingency, commitment  or  diminution in the value of assets  known  to exist  at the time of the balance-sheet, it was  a  reserve. The  amount set aside out of profits and other surpluses  to profit for any known liability for which the amount could be determined with certainty, it is a provision. [27H]      Creating  of  reserve  out of the  profit  is  a  stage distinct  in point of fact and anterior in point of time  to the  stage of making recommendation for payment of  dividend by the general body of the shareholders. [28A]      The  true  nature and  character of the  disputed  sum, therefore must be determined with reference to the substance of  the  matter and not by the mere  entry  or  nomenclature which the assessee company had chosen to be given. [27G]      A  sum of Rs. 76,00,000 worked out for the  payment  of dividend and appropriated by subsequent resolution was  only a  provision and the residue of Rs. 14,00,000  was  reserve. [28C]      Though  the general body of the  shareholders  resolved and  appropriated  on  May 31,1963 of the  dividend  of  Rs. 76,00,000 from the reserve of Rs. 90,00,000 it related  back to  the relevant assessment year, and therefore, as  on  Ist January,  1963,  Rs. 76,00,000 was provision and  cannot  be computed as capital.  Only Rs. 14,00,000 would be    treated to be reserve. [30F-G]      Metal  Box  Co.  of India Ltd. v.  Their   Workmen;  73 I.T.R. 53; Commis-                                                   24 sioner of Income-tax, Mysore v. Mysore Electrical Industries Ltd.,  1971  (80)  I.T.R. 566; Hyco  Products  (P)  Ltd.  v. Commissioner of Income-tax, Bombay referred to.      Vazir  Sultan  Tobaccoo  Co. Ltd.  v.  Commissioner  of Income-tax, A.P. [1981] 132 I.T.R. 559, not applicable

JUDGMENT:      CIVIL  APPELLATE JURISDICTION : Civil Appeal  No.  1254 (NT) of 1976.      From  the  Judgment and Order dated  23.8.1974  of  the Calcutta High Court in Income Tax Reference No. 241 of 1970      Janaki  Ramachandran, R. Ayyam Perumal and  D.N.  Gupta for the Appellants.      Dr V. Gauri Shankar, P Parmeshwaran, S. Rajappa and Ms. A. Subhashini for the Respondents.

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    The Judgment of the  Court was delivered by      K.  RAMASWAMY,J.  This  appeal,  by  certificate  under Section  261  of the Indian Income-tax Act 1961  (for  short ‘the Act’) granted by the Calcutta High Court, arises from a reference under Section 256 (1) of the Act and Section 18 of the  Companies  (Profits) Sur-tax Act,  1964  (for  ‘Sur-tax Act’) on the question of law which was answered in  negative and against the appellant thus :               "Whether on the facts and in the circumstances          of the case the Tribunal was right in holding  that          a  sum of Rs. 76,00,000 which was paid as  dividend          for  the  year 1962 following the  General  Meeting          dated  31st May, 1963 out of the  dividend  reserve          of  Rs. 90,00,000 as on the Ist January,  1963  was          not  to be taken into account for  the  computation          of   capital  as  on  the  Ist  January,  1963   in          pursuance  of the rules of the Second  Schedule  to          the Companies (Profits) Sur-tax Act 1864."      The  previous year relevant to the assessment year,  of the paid up capital, the reserve, the debentures etc.  under Rule  1  of  second  Schedule to the  Sur-tax  Act,  is  the Calendar  Year 1963.  The assessment year is  1964-65.   The position  of the capital was to be considered as on the  Ist day  thereof  i.e. 1.1.1963.  The appellant claimed  in  its assessment  a  sum  of  Rs.  90,00,000  transferred  to  the dividend reserve as a reserve entering into capital compu-                                              25 tation.  The assessing authority excluded this sum from  the computation  of  the  capital but on  appeal  the  Appellate Asstt.  Commissioner found it to be a reserve created out of amounts  which  had  not  been  allowed  as  deduction   for computing  the  profits of that year.  Accordingly  he  held that  Rs.  90,00,000  was the  reserve  fund  qualified  for inclusion  under Rule 1 (III) of the Second Schedule to  the Sur-tax  Act.   On  appeal by the  Revenue,  the  Income-tax Appellate Tribunal held that "the assessee had  appropriated Rs.  76,00,000 out of the year’s profit and transferred  the balance  of  Rs. 14,00,000 to the dividend  reserve"  :  Rs. 76,00,000  was taken as liability as on 1.1.1963 and as  the creation  of  Rs. 90,00,000 was to be taken  as  reserve  on 1.1.1963 only a sum of Rs. 14,00,000 has been transferred to the  reserve account.  Accordingly the Tribunal held that  a sum  of Rs. 14,00,000 would only be treated as  a  provision and   directed  modification  of  the  capital   computation accordingly. On reference at the behest of the appellant the High Court answered the question in the negative and against the assessee.      Section  4  of the Sur-tax Act,  the  charging  section postulates that, subject to the provision contained therein, there  shall  be  a  charge   on  every  company  for   very assessment year commencing on and from the Ist day of April, 1964, a tax in respect of so much of its chargeable  profits of the previous year or pervious years as the case may be as exceeds  the  statutory  deduction, at  the  rate  or  rates specified  in  the Third Schedule.  Section  2  (5)  defines chargeable profits as a total income of an assessee computed under the Act for any previous year or years as the case may be  and  adjusted in accordance with the provisions  of  the First  Schedule. Section 2 (8) accords statutory  deduction, an amount equal to 10 per cent of the capital of the company as computed in accordance with the provisions of the  Second schedule  or  an amount of Rs. 200  thousands  whichever  is greater.    The  First  Schedule  provides  the  rules   for computation of the chargeable profits.  The Second  Schedule gives  the procedure to compute the capital of  the  company

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for  the purpose of sur-tax.  Rule 1 of the Second  Schedule postulates  that, subject to the other provisions  contained in  the Second Schedule, the capital of a company  shall  be the  aggregate  of the amounts as on the first  day  of  the previous  year, relevant to the assessment year of its  paid up share capital, its reserve, if any, and other reserves as reduced  by  the amounts credited to such reserves  as  have been  allowed as a deduction in computing the income of  the company  for the purpose of the Indian Income-tax  Act,  its debentures;   if   any,  or  any  borrowed   amounts.    The explanation thereto provides thus :                      "For the removal of doubts it is hereby            declared            that any amount  standing  to            the credit of any           account in the  books            of  a  company  as  on  the  first  day  of   the            previous year relevant to the assessment                                                   26           Year  which is of the nature of item (5)  or  item           (6)  or item (7) under the heading  "Reserves  and           Surplus"  of any item under the  heading  "Current           Liabilities and Provision" in the column  relation           to  "Liabilities’ in the ‘Form of  Balance  Sheet"           given  in  Part  1  of  the  Schedule  VI  to  the           Companies  Act, 1956 (1) or of 1956 shall  not  be           regarded   as  a  reserve  for  the   purpose   of           computation of the capital of a company under  the           provisions of this schedule."      Section  217  of the Companies Act,  1956  enjoins  the company  to  attach  to every balance sheet  laid  before  a company general meeting, a report by its Board of Directors, with respect to :      (a) the state of the company’s affairs;      (B) The amounts, if any, which it proposes to carry  to any reserves in such balance sheet; and      (c)  the amount, it any, which it recommends should  be paid by way of dividend;......"      Regulation 87 of table A of the First Schedule empowers the  Board to recommend any dividend set aside, out  of  the profits  of the company, such sum as it thinks proper  as  a reserve or reserves etc.      It is found as a fact that on Ist May, 1963 in  respect of the accounts for the year 1962 in the Director’s  meeting of the assessee company it approved the transfer of a sum of Rs. 90,00,000 out of the profits for the year to a ‘Dividend Reserve Account’ 12-1/2% which amounted to Rs. 76,00,000  on the ordinary shares on the amount paid on those shares prior to  31st December, 1962.  On 31st May, 1963 in  the  general meeting the accounts were passed by the shareholders and the dividend  as  recommended  by the  Directors  was  declared. Subsequently,  the dividend was paid and it was adjusted  by transferring Rs. 76,00,000 from the dividend reserve account through the Profit and Loss Appropriation Account.      In  its report, the Board of Directors stated that  the Auditor’s  Report presented the ‘company affairs as on  31st December,  1962 and its profits for the year ended  on  that date’.  In the balance sheet under the heading ‘Liabilities’ as on 31st December, 1962 under the sub heading ‘Provisions’ item  (c) "Proposed Dividend" shows the figure "to be  nil". The  Schedule  forming part of the balance sheet  under  the head  ‘Reserve  and  Surplus’ under item  (e)  the  Dividend Reserve  Account stated that from the transfer of  a  Profit and Loss Account was Rs. 90,00,000                                              27      The  question,  therefore,  is whether  a  sum  of  Rs. 90,00,000 or any part thereof would be reserve for computing

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the capital as on January 1, 1963.  From the above fact,  it is  clear  that  a sum of Rs.  76,00,000  earmarked  by  the director’s recommendation dated May 3,1963 as dividend,  was approved by the general body meeting of the shareholders  on May 31, 1963 and the same was paid over to the  shareholders and  in the balance sheet this liability was treated  as  on December 31, 1962 to be nil.  The purpose of the Sur-tax Act is  to impose Sur-tax on the profits of a company.  The  Act also  intended  to  impose  tax on  the  net  profits  after allowing  deductions  in terms of the Sur-tax  Act  and  the procedure  for computation thereof was indicated in the  2nd schedule.   In the computation, the profits, the capital  or reserve forming capital of the company, had to be  excluded. It is well known that the accounts of the company have to be brought up for a year upto a particular date.  On the  facts of  this  case  the crucial date is  1.1.1963.   If  it  was reasonably  practicable to make up the accounts as  on  that date and present the same to the directors of the company as on December 31, 1962 and the balance sheet thereof is placed before  the general body meeting of the share-holders as  on that date, they could have made up their minds on that  date and  declared their intention of appropriating the  dividend or  any  other  sums  to  reserves  of  different  heads  of liabilities.  But the fact remains that it was not done  for the obvious reason that the calculation or collection of the figures  of all the items of income and expenditure  of  the company  of the previous year ending December 31,  1962  was bound  to  take  some time and it was not  done.   The  fact remains  that the shareholders in the general  body  meeting held  on May 31,1963 resolved to appropriate  Rs.  76,00,000 towards dividend payable to the shareholders and accordingly it was appropriated and paid over.  The question, therefore, is whether the amount of Rs. 76,00,000 appropriated  relates back  as on January 1,1963.  On recommendation by the  Board of  Directors and acceptance thereof by the general body  of the shareholders to pay dividend at a particular percentage, the  liability  came  into existence and  by  their  act  of appropriation  by  adjusting  the  reserve  as  against  the liability  it  became  crystalised.   There  is  nothing  to withhold  payment in species to the respective  shareholders which  is  merely  a ministerial act.   The  modus  operandi adopted  in making the entries or nomenclature chosen to  be given are not conclusive but  the heart of the matter is the nature  and substance of the manner in which  the  company’s accounts are prepared.  The true nature and character of the disputed  sum, therefore, must be determined with  reference to the substance of the matter and not by the mere entry  of nomenclature  which  the assessee company had chosen  to  be given.   If an amount is satisfied out of profits and  other surpluses,   not   to  meet  the   liability,   contingency, commitment  or  diminution in the value of  asset  known  to exist  at the time of the balance sheet, it was  a  reserve. The amount set aside out of profits and                                                   28 other surpluses to profit for any known liability for  which the  amount  could be determined with certainity, it  is   a provision.  Creating of reserve out of the profit is a stage distinct  in point of fact and anterior in point of time  to the  stage of making recommendation for payment of  dividend by the general body of the shareholders.  A conjoint reading of  the  scheme  of the Sur-tax Act and  the  company’s  Act suggests  that  the  appropriation  made  by  the  Board  of Directors by recommending payment of dividend, in the nature of things does not constitute a reserve.  The resolution  by the general body of the shareholders to make dividend out of

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profits  at  a  particular  percentage  crystalised  into  a liability,  and  subsequent  payment  relates  back  to  the relevant  date,   namely,  closing of  the  accounting  year during  which  the  liability had  arisen.   Therefore,  the resolution of the general body of the shareholders dated May 31,  1963 had retrospective effect inasmuch as it refers  to the  profits of the previous year ending December 31,  1962. Therefore, a sum of Rs. 76,00,000 worked out for the payment of  dividend and appropriated by subsequent  resolution  was only  a  provision  and the residue  of  Rs.  14,00,000  was reserve.      In  Metal  Box Co of India Ltd. v.  Their  Workmen,  73 I.T.R.  53  this Court was concerned  whether  appropriation amounted to reserve or provision.  Dealing with the question of payment of bonus to the workmen and appropriation thereof on  that  account,  this Court  held  that  the  distinction between  a  provision  and  a  reserve  was  in   commercial accountancy fairly well known.  Provision were made  against anticipatory  losses and contingencies were charged  against profit  and they had been taken into account  against  gross receipts  in the profit and loss account and balance  sheet. On  the other hand, reserves were appropriation of  profits, the assets by which these were represented being retained to form part of capital employed in their business.  provisions were  usually shown in the balance sheet by  deduction  from the  asset  in respect of   which those  were  made  whereas general  reserve  and  reserve fund were shown  as  part  of proprietor’s  interest.  An amount set aside out of  profits and  other  surpluses,  not designed to  meet  a  liability, contingency, commitment or diminution in valuation of  asset known  to  exist  on the date of the  balance  sheet  was  a reserve  but  an amount set aside out of profits  and  other surpluses,  was provided for known liability for  which  the amount could not determined with substantial accuracy was  a provision.  In Commissioner of Income-tax, Mysore V.  Mysore Electrical   Industries   Ltd.  1971  (80)  I.T.R.   566   a constitution   bench   of   this   Court   held   that   the determination  of the directors to appropriate the  accounts to  the three times of reserve on August 8, 1963 had  to  be related to April 1, 1963 i.e. the beginning of the  accounts in the new year and had to be treated as effective from that date and the three items had to be added to the other  times for computation of the capital of the respondent as on April 1, 1963 under Rule                                                   29 1  of  Schedule  II of the Sur-tax Act.  In  that  case  the Revenue  contended  that since the  appropriation  was  made after  the accounting year it would not relate back  to  the assessment year.  Rejecting that contention this Court  held that although such allocation was factually not possible  on the  very first day of a year but allocation on a later  day should be treated as effective from that date in view of the fact  that   the division of  undistributed  profits  became effective from that date.  The case of Vazir Sultan Tobaccoo Co  Ltd. v. Commissioner of Income-tax, A.P. 1981 [132]  ITR 559,  relied  on  by  the assessee,  far  from  helping  the appellant,  goes  against  the  contention  of  the  learned counsel  for the appellant.  Construing Section 217  of  the Company’s Act 1956 and the Schedule this Court held thus :           "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

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        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  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  assessee strenuously contended before us  that          once  it  was  shown  or  became  clear  that   the          retention or appropriation of a sum out of  profits          and sur-pluses 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                                                   30           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".      This  Court in Hyco Products (P) Ltd. v. C.I.T.  Bombay (supra) approved the ratio of the Bombay High Court in  Ref. case  No.  5 of 1978 of Hyco Products (P) Ltd.  Bombay.  The question  therein  relates to the assessment  year  1974-75. The relevant provision being the calendar year 1963 and  the material date being January 1,1973 after the accounts of the year  were finalised, the directors transferred, out of  the profits  of  Rs.  61,03,382  of that  year,  a  sum  of  Rs. 29,77,000 to the general reserve.  With such a transfer  the general  reserve  of the assessee company as on  January  1, 1973, stood at Rs. 36,07,712 at the end of the calendar year 1972.  In the annual general meeting held on June 30,  1973, dividend  of Rs. 3,10,450 was declared by  the  shareholders and  the  same  was soon thereafter paid  out  of  the  said

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general reserve.  In the Sur-tax assessment proceeding under the  1964 Act the assessee claimed that the  entire  general reserve  which stood at Rs. 86,07,712 as on January 1,  1973 should be taken into account while computing the capital  of the  assessee  company.   It was  negatived  by  the  taxing officer who deducted Rs. 3,10,450 from the  general  reserve and  the  balance was added to the capital.   The  Appellate Commissioner and the Income-tax Appellate Tribunal confirmed the  order.  On reference, the High Court upheld  the  order which was approved by this Court.      Thus  we  have no hesitation to hold  that  though  the general  body of the shareholders resolved and  appropriated on  May 31, 1963 to the dividend of Rs. 76,00,000  from  the reserve  of Rs. 90,00,000, it related back to  the  relevant assessment  year, and therefore as on Ist January  1963  Rs. 76,00,000  was provision and cannot be computed as  capital. Only  Rs.  14,00,000 would be treated to  be  reserve.   The Tribunal and the High Court, therefore, correctly laid  down the law and it does not warrant interference.  The appeal is accordingly  dismissed but in the circumstances parties  are directed to bear their own costs. Y. Lal                                  Appeal dismissed.                                                   31