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PETITIONER: VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC.

       Vs.

RESPONDENT: COMMlSSIONER OF INCOME-TAX ANDHRA PRADESH, HYDERABAD

DATE OF JUDGMENT25/09/1981

BENCH: TULZAPURKAR, V.D. BENCH: TULZAPURKAR, V.D. VENKATARAMIAH, E.S. (J) SEN, AMARENDRA NATH (J)

CITATION:  1981 AIR 2105            1982 SCR  (1) 789  1981 SCC  (4) 435        1981 SCALE  (3)1483  CITATOR INFO :  RF         1986 SC 484  (13,17)  F          1986 SC1746  (6)  R          1986 SC1938  (5,13,14,16,17)

ACT:      Super Profits  Tax Act,  1963 and  Company’s  (Profits) Sur-tax  Act,  1964-Rule  I  of  Second  Schedule-Scope  of- "Provision"  and   "Reserve"-Distinction-  A  sum  of  money transferred  from   current  profits  to  general  reserves- Dividend paid from that fund-General reserve how calculated.

HEADNOTE:      The Super  (Profits Tax)  Act, 1963  and the  Company’s (Profits) Sur-tax  Act, 1964 (the scheme and main provisions of both  of which are almost identical) impose a special tax on excess  profits earned  by companies.  The special tax is imposed in  respect of  so much  of a  company’s "chargeable profits" of  the previous  year as  exceeded  the  "standard deduction"- The  term "chargeable profit" is defined to mean the total  income of  an assessee  computed under the Income Tax  Act,  1961  for  any  previous  year  and  adjusted  in accordance  with  the  provisions  of  that  Act.  "Standard deduction" is  determined by  computing  the  capital  of  a company in  accordance with  the  rules  laid  down  in  the schedule. The  material part  of rule I provides that before any  amount  or  sum  qualifies  for  inclusion  in  capital computation of  a company  two conditions are required to be fulfilled namely:  (i) that  the amount  or sum  must  be  a "reserve" and  (b) that  it must  not have  been allowed  in computing the  company’s profit  for the  purposes of Income Tax Acts, 1922 or 1961.      ln their  respective balance  sheets, the assessees had shown under the heading "current liabilities and provisions" appropriations  of   large  sums   of  money  for  taxation, retirement gratuity  and dividends  and claimed that for the purposes of  super profits tax these sums should be regarded as "other  reserves" within  the meaning of Rule 1 of Second Schedule to  the Act and that for the computation of capital they should be taken into account.      Treating  these   sums  as   "provisions"  and  not  as "reserves", the  Super Profits  Tax officer  determined  the

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capital and  the standard  deduction by  excluding them from the computation of the capital. He then levied super profits tax on  that  portion  of  the  chargeable  profits  of  the previous year as exceeded the standard deduction.      While the  Appellate Assistant  Commissioner upheld the assessee’s contention  that these sums were "reserves" which should be  taken into  account for  computing their capital, the Appellate  Tribunal held  that these were not "reserves" within 790 the meaning  of Rule l of the Second Schedule to the Act and as such could not enter into capital computation.      On reference  the High  Court held  that the  sums  set apart were  not "reserves  and so  should be excluded in the computation of  the capital  for the purposes of levying the super profits tax.      In Tax  Reference no.  5 (a  case under  the  Companies (Profits) Sur-tax  Act, 1964)  the assessee transferred from out of  its current  profits a  large sum  of money  to  the general reserves  and paid dividend to its shareholders from out of  the augmented  general  reserves.  On  the  question whether for computing the capital for the purpose of sur-tax the general  reserves should or should not be reduced by the sum  of  dividend  paid,  the  taxing  authorities  and  the appellate tribunal  ignored this  amount holding that it was not a "reserve".      None of  the items of appropriation either for taxation or for  retirement gratuity  or for proposed dividend in the assessees’ cases had been allowed in computing their profits under the Income Tax Act, 1961. ^      HELD: [per Tulzapurkar & Venkataramiah, JJ]      The expressions "reserve" and "provision" have not been defined in  the Act.  Standard dictionaries,  without making any distinction  between the  two concepts, use them more or less synonymously  connoting the same idea. But since in the context of  the legislation  a clear distinction between the two is implied it is essential to know the exact connotation of  the  two  concepts  and  the  distinction  as  known  in commercial accountancy. The rules for computation of capital contained in  the Second  Schedule to the Act proceed on the basis of the formula of capital plus reserve, a formula well known in  commercial accountancy.  But since they occur in a taxing  statute   applicable   to   companies   only   these expressions will  have to  be understood  in  the  sense  or meaning attributed  to them  by men  of business,  trade and commerce and  by  persons  interested  in  or  dealing  with companies. Therefore, the meaning attached to these words in the Companies  Act, 1956 would govern their construction for the purpose of these two enactments [800 C-H]      The broad  distinction between  the two  expressions as judicially  evolved   by  this   Court  is   that,  while  a "provision" is a charge against the profits to be taken into account against  gross  receipts  in  the  profit  and  loss account, a  "reserve" is  an appropriation  of profits,  the asset or assets by which it is represented being retained to form part of the capital employed in the business. [801 F]      C.l.T. v.  Ccntury Spinning & Manufacturiag Co., 24 ITR 499 and Metal Box Company of India Ltd. v. Their Workmen, 73 lTR 67 followed.      The Companies  Act, which  enjoins upon  the  Board  of Directors of  every company to lay before the annual general meeting of  its shareholders  an annual  balance sheet and a profit and  loss account, enumerates the separate heads that should be  shown in  the balance  sheet, two  of these items

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being "reserve’  and "provision".  The definitions  of these two expressions given in the Act show 791 that if any retention or appropriation of a sum falls within the definition of A "provision" it can never be a "reserve". But  the   converse  is   not  true.  If  the  retention  or appropriation is  not a  "provision" that  is, if  it is not designated to  meet depreciation,  renewals or diminution in value  of   assets  or   any  known   liability  it  is  not automatically a  "reserve" and  the question will have to be decided having  regard to  the true  nature and character of the sum  so retained  or appropriated  depending on  several factors, including the intention with which and the purposes for which  such retention  or appropriation  had been  made. [803 E-Fl      Having regard  to the  type of  definitions of  the two concepts, if  a particular  retention or  appropriation of a sum falls  within the  expression "provision"  then that sum will have to be excluded from the computation of capital. If the sum  is in  fact a "reserve" then it would be taken into account for the computation of capital. [804 B-C]      Where the assessee had set apart a sum of money to meet tax  liability  in  respect  of  profits  earned  during  an accounting year,  which liability  was not  quantified, such setting apart for a known and existing liability, would be a "provision" and  could not  be regarded as a "reserve". [806 A-C]      Kesoram Industries and Cotton Mills Ltd.v. Commissioner of Wealth Tax  (central) Calcutta, 59 ITR 767 followed.      But if  provision for  a known or existing liability is made in  excess of  the amount  reasonably necessary for the purpose, such  excess should  be treated  as  reserve"  and, therefore, would  be includible in capital computation. [806 E]      Since the assessee (in C.A. No. 860/73) had at no stage of  the   proceedings  before   the  Taxing  Authorities  or Appellate Tribunal  or the High Court raised a plea that the provision made  by it  for taxation  was in  excess  of  the amount reasonably  necesssary for  the purpose and that such excess should  be treated  as a  "reserve", the  plea  which needs investigation  into facts,  could not be allowed to be raised for  the first time in appeal before this Court. [807 F]      Ordinarily an  appropriation to  gratuity reserve  will have to  be regarded  as a  provision made  for a contingent liability, for,  under a  scheme framed  by  a  company  the liability to  pay gratuity  to its employee on determination of  employment  arises  only  when  the  employment  of  the employee is  determined by  death, incapacity, retirement or resignation-an event  (cessation of  employment) certain  to happen in  the service  career of  every employee. Moreover, the amount  of gratuity  payable is usually dependent on the employee’s wages  at the  time of  G, determination  of  his employment and  the number of years of service put in by him and the  liability accrues  and enhances  with completion of every year  of service;  but the  company can work out on an acturial valuation  its estimated liability (i.e. discounted present value  of  the  liability  under  the  scheme  on  a scientific basis)  and make  a provision  for such liability not all  at once  but spread  over a  number of years. If by adopting such  scientific method  any appropriation  is made such appropriation  will constitute a provision representing fairly accurately  a known  and existing  liability for  the year in question; if however, an ad hoc sum 792

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is appropriated  without resorting  to any  scientific basis such appropriation  would also  be a  provision intended  to meet a  known liability,  though a  contingent one, for, the expression ’liability’  occurring in  cl. (7)(1)(a)  of Part III of  Sixth Schedule  to the  Companies Act  includes  any expenditure contracted  for and  arising under  a contingent liability: but  if the sum so appropriated is shown to be in excess of  the sum  required to meet the estimated liability (discounted present  value on a scientific basis) it is only the excess  that will have to be regarded as a reserve under clause (7)  (2) of Part III to the Sixth Schedule. [807 G.H; 808 A-D]      In the  instant case  although the  assessee had  urged before the  authorities below  that different  treatment for the same  item could not be given for purposes of income tax assessment and super profits tax assessment the assessee did not clarify  by placing  material on  record as  to  whether appropriation was based on any acturial valuation or whether it was  an appropriation  of an  ad hoc amount a which has a vital bearing  on the  question, whether  the  appropriation could be  treated as  a provision or reserve. In the absence of proper  material the  question should  be decided  by the taxing  authorities   whether  the   amount  set  apart  and transferred to  gratuity reserve by the assessee company was either a  provision or  a reserve  and if the latter to what extent. [812 C-E]      Standard Mills  Co. Ltd. v. Commissioner of Wealth-Tax, Bombay, 63,  I.T.R.470 & Workmen of William Jacks & Co. Ltd. v. Management of Jacks & Co.Ltd; Madras. [1971] Supp. S.C.R. 450 followed.      Southern Railway  of Peru  Ltd. v. Owen [1957] A.C. 334 referred to.      The  appropriations  of  an  amount  by  the  Board  of Directors by  way of  providing for  proposed dividend would not constitute  ’provision’, for,  the appropriations cannot be said  to be by way of providing for any known or existing liability, none having arisen on the date when the Directors made recommendation much less on the relevant date after the first day  of the  previous year  relevant to the assessment year in  question. This  by itself  would  not  convert  the appropriations into "reserves". [813 E-F]      The tests  and guidelines  laid down  by this  Court in this respect  are: (1)  the true nature and character of the appropriation must  be  determined  with  reference  to  the substance in  the matter,  which means  that one  must  have regard to the intention with which and the purpose for which appropriation has been made such intention and purpose being gathered from  the  surrounding  circumstances.  A  mass  of undistributed profits cannot automatically become a reserve. Some body  possessing the  requisite authority  must clearly indicate that  a  portion  thereof  has  been  earmarked  or separated from  the general  mass of  profits with a view to constituting it  either a  general  reserve  or  a  specific reserve; (2)  the surrounding  circumstances should  make it apparent that  the amount  so earmark  ed or set apart is in fact a  reserve to  be utilised  in future  for  a  specific purpose on  a specific  occasion; (3) a clear conduct on the part of the Directors in setting apart a sum from out of the mass of  undistributed profits  avowedly for  the purpose of distribution of  dividend in the same year would run counter to any  intention of  making that  amount a reserve, (4) the nomenclature accorded  to any  particular fund  which is set apart from out of the profits would not be material 793 Or decisive  of the  matter; and (5) if any amount set apart

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from out  of the  profits A is going to make up capital fund of the  assessee and  would be available to the assessee for its business purposes it would become a reserve liable to be included in  the capital  computation of  the assessee under that Act. [815 F-H, 817 G]      The relevant  provisions of  the Companies  Act clearly show that  creating reserves  out of  the profits is a stage distinct in  point of  fact and anterior in point of time to the stage  of making  recommendation for payment of dividend and the scheme of the provisions suggests that appropriation made by  the Board  of Directors  by way  of recommending  a payment of  dividend cannot  in the  nature of  things be  a reserve. [818 F-G]      Judged  in  the  light  of  the  above  guidelines  the appropriations made  by the  Directors for proposed dividend in the  case of  the concerned  assessee companies  did  not constitute ’reserves’ and the concerned amounts so set apart would  have   to  be   ignored  or   excluded  from  capital computation. [818 H]      Standard Mills  Co. Ltd.  v. Commissioner of Wealth-tax Bombay, 63  I.T.R.470, Metal  Box Co. Of India Ltd. v. Their Workmen, 73 ITR 67, First National City Bank v. Commissioner of Income-Tax,  42 ITR  67 &  Commissioner  of  Income-  tax (Central), Calcutta  v. Standard  Vacuum oil Co., 59 ITR 685 followed.      Although under  the Companies  Act it  is open  to  the Directors to  recommend and  the  share-holders  to  approve payment of  dividend from the current year’s profits or from the past  year’s profits and on transfer of a portion of the current year’s  profit to  the general reserve the augmented general reserve  becomes a  congolmerate fund, having regard to the  natural course  of human conduct it is not difficult to predicate  that dividends  would ordinarily  be paid  out from the  current income  rather than from the past savings, unless  the   directors  in   their  report   expressly   or specifically state  that payment  of dividends would be made from the past savings. From the commercial point of view, if any amount  is required  for incurring  any  expenditure  or making any  disbursement like distribution of dividends in a current year,  ordinarily the  same will  come  out  of  the current income of the company if it is available and only if the sum  is insufficient  then  the  past  savings  will  be resorted to for the purpose of incurring that expenditure or making that  disbursement. Such  a course would be in accord with the common sense point of view. [822 C-F]      In the  absense of  express indication  to the contrary the normal  rule for a commercial concern would be to resort to current  income rather  than past savings while incurring any expenditure or making any disbursement. [822 H]      Commissioner of  Income-Tax, Bombay  City-l  v.  Bharat Bijlee Ltd. 107 ITR 30; & Commissioner of Income-Tax, Bombay City-ll v. Marrior (India) Ltd. 120 ITR Sl 2 approved. [per A.N. Sen, J.]      The amount  set  apart  for  payment  of  any  dividend recommended by  the Board  of Directors is not an amount set apart for meeting a known or existing 794 liability and  cannot be considered to be a "reserve" within the meaning  of the  Act for  the purposes of computation of the capital of the company. [832 F]      The Companies Act, 1956 provides for the preparation of annual balance  sheet in  the prescribed  form and laying it before the  shareholders  at  the  annual  general  meeting. Regulation 87,  Table A  in Schedule I contemplates that the Board may  set aside  out of  the  profits  of  the  company

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certain sum  as "reserve"  before dividend is recommended by it. The  amount recommended  by the  Board  for  payment  of dividend is  shown in  the  balance  sheet  under  the  head "provision" and  not under  any head  of "reserve". The true nature and  character of  the  sum  so  set  apart  must  be determined with  regard to the substance of the matter which in this case is that the sum set apart was never intended to constitute a "reserve’ of the company. [833 F, 834G]      In law  the liability  for payment  of dividend  arises only when  the share-holders accept the recommendations made by the  Directors. Till  then it is open to the Directors to modify  or   withdraw  their  recommendation  before  it  is accepted by  the shareholders  and it is equally open to the share-holders  not  to  accept  the  recommendation  in  its entirety. Even  so, for business purposes when the Directors make any  recommendation for  payment of  dividend  and  set apart any  amount for  this purpose  the Directors intend to make a provision and do not create any reserve, as Directors know that  their recomendation  is generally accepted by the shareholders as a matter of course. Therefore any amount set apart for  this purpose  is understood by persons interested in company  matters and  in dealing with companies to mean a provision for  the payment  of dividend  to the shareholders and is not understood to constitute a "reserve". [832 C-F]      Commissioner  of  lncome-tax  Bombay  City  v.  Century Spinning and  Manufacturing Co.  Ltd. [1953]  24 I.T.R. 499, Commissioner of  Income Tax  v.  Standard  Vaccum  oil  Co., [1966] 59  I.T.R. 685,  Metal  Box  Co.  Of  Ltd.  v.  Their Workmen, [1963]  73 I.T.R, 53, Commissioner of Income-tax v. Mysore Electrical  Industries Ltd., [1971] 80 l.T.R. 567 and Kesho Ram  Industries and Cotton Mills Ltd v.Commissioner of Wealth  Tax   (Central),  Calcutta,  [1966]  59  I.T.R.  767 referred to.

JUDGMENT:      CIVIL APPELLATE  JURISDICTION: Civil  Appeal No. 860 of 1973.      From the  judgment and  order dated  the 1st September, 1972 of  the Andhra  Pradesh High Court at Hyderabad in R.C. No. 10 of 1971.                             AND                Civil Appeal No. 1614 (NT) of 1978.      Appeal by  Special Leave  from the  judgment and  order dated the 26th July, 1976 of the Calcutta High Court in l.T. Reference No.454 of 1974.                             AND                     Review Petition No. 57 of 1980. 795                              IN           Special Leave Petition (Civil) No. 4602 of 1977      From the  judgment and  order dated the 11th June, 1974 of the  Calcutta High  Court in  I.T. Reference  No. 195  of 1969.                             AND                Tax Reference Case Nos. 2 and 3 of 1977.      Income-tax Reference  under section  257 of the Income- tax Act, 1961 drawn up by the Income-tax Appellate Tribunal, Bombay Bench  ’B’ in R.A. Nos. 1223 and 1224 (Bom.) of 1972- 73 (I.T. A. Nos. 24 and 25 (Bom.) of 1971-72.                             AND                     Tax Reference Case No. S of 1978.      Income Tax  Reference under  section 257  of the Income Tax Act,  1961 made  by the  Income Tax  Appellate Tribunal,

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Bombay Bench  "D" in  R.A. No. 225 (Bom.) of 1977-78 arising out of S.T.A.No. 36 (Bombay) 1 1976-77.      A. Subbarao  and Y.V.  Anjaneyulu for  the appellant in Civil Appeal No. 860/73. E      V.S. Desai,  Dr. Debi Pal, Praveen Kumar and Anil Kumar Sharma for  the Appellant  in C.A.  1614 of 1978 and for the Petitioner in Review Petition No. 57/80.      K.G. Haji  and R.J.  John  for  the  Appellant  in  Tax Reference Case Nos. 2 and 3 of 1977.      S.E.  Dastur,   S.N.  Talwar  and  R.J.  John  for  the Appellant in Tax Reference Case No. 5 of 1978.      S.T. Desai,  J. Ramamurthi  and Miss  A. Subhashini for the Respondent in Civil Appeal No. 860/73.      Miss A.  Subhashini for  the Respondent in Civil Appeal No.1614 of 1978      S.C.  Manehanda   and  Miss   A.  Subhashini   for  the Respondent in Tax Reference Nos. 2 and 3 of 1977. 796      S.C. Manchanda,  Anil Dev  Singh and Miss A. Subhashini for the Respondent in Tax Reference Case No. 5/1978.      S P. Mehta and K.J. John for the Intervener.      Dr. Debi  Paul and  K.J. John for the Intervener in Tax Reference Case No. 5/1978.      The following Judgments were delivered:      TULZAPUKKAR,  J.   In  these   Civil  Appeals  and  Tax Reference Cases  certain common  questions of  law arise for our determination  and hence  all these  are disposed  of by this  common  judgment.  The  common  questions  raised  are whether amounts retained or appropriated or set apart by the concerned assessee  company by  way of  making provision (a) for taxation,  (b)  for  retirement  gratuity  and  (c)  for proposed dividends  from out  of profits and other surpluses could be  considered as  "other reserves" within the meaning of Rule  I of  the Second  Schedule to the Super Profits Tax Act, 1963 (or Rule 1 of the Second Schedule to the Company’s (Profits)  Sur-tax  Act,  1964)  for  inclusion  in  capital computation of  the Company for the purpose of levying super profit tax ? The first three matters concerning Vazir Sultan Tobacco Co.  Ltd; Hyderabad,  Ballarpur lndustries, Ltd; and M/s. Bengal  Paper Mills  Co. Ltd;  Calcutta arise under the Super Profits  Tax Act,  1963 while  the the  Tax  Reference Cases concerning  M/s. Echjay  Industries Pvt. Ltd. and Hyco Products  Pvt.   Ltd.  Bombay   arise  under  the  Companies (Profits) Sur-tax Act.1 964.      Since Civil  Appeal  No.  860  of  1973  (Vazir  Sultan Tobacco Company’s  case) is  comprehensive and comprises all the three  items of  appropriation it  will be sufficient if the facts  in this  case are  set out  in detail  so  as  to understand how  the questions  for  determination  arise  in these matters. Vazir Sultan Tobacco Co. Ltd. was an assessee under the  Super (Profits)  Tax Act,  1963. For  the assess- ment year  1963-64, for which the relevant accounting period was the year which ended 30th September, 1962, for computing the chargeable  profits of that year for the purpose of levy of super  profits tax  under the  Act, the  assessee company claimed that  the appropriations  of a)  Rs.  33,68,360  for taxation, (b)  Rs. 9,08,106  for retirement gratuity and (c) Rs. 18,41,820  for dividends  (all of which items were shown under the  heading ’current  liabilities and  provisions’ in the concerned balance-sheet as at 30th Sept. 1962) should be regar- 797 ded as  "other reserves"  within the  meaning of  Rule 1  of Second  A   Schedule  to  the  Act  and  be  included  while determining its  capital.  The  Super  Profits  Tax  officer

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rejected the  assessee’s contention  as in  his opinion  all these items  were "provisions  ’ and  not "reserves"  and as such these  had to  be ignored  or excluded from the capital computation of  the assessee  company and  on that  basis he determined the  capital,  and  the  standard  deduction  and levied super  profits tax  on that portion of the chargeable profits of  the previous  year which  exceeded the  standard deduction. In  the appeal  preferred by the assessee company against the  assessment, the  Appellate Commissioner  upheld the assessee’s  contentions and  held that  those items were "reserves" and  took them  into account  while computing the capital of  the assessee  company.  In  the  further  appeal prefer- red  by  the  Super  Tax  officer,  the  Income  Tax Appellate Tribunal  accepted the Department’s contention and held that  these were  not "reserves"  within the meaning of Rule I  of the  Second Schedule to the Act and as such these could not  enter into  capital computation  of the  assessee company. In the Reference that was made under section 256(1) of the  Income Tax  Act, 1961  read with  s. 10 of the Super Profits Tax  Act at the instance of the assessee company the following question of law was referred to the Andhra Pradesh High Court for its opinion:           "Whether on  the facts and in the circumstances of      the case the provisions (a) for taxation Rs. 33,68,360,      (b) for  retirement gratuity  Rs. 9,08,106  and (c) for      dividends Rs. 18,41,820, could be treated as ’reserves’      for computing  the capital  for the  purpose  of  super      profits tax  under Second Schedule to the Super Profits      Tax Act, 1963 for the assessment year 1963-64 ?" F      The  High   Court  on   a  consideration   of   several authorities answered  the question  in respect  of the three items in  favour of  the Revenue  and against  the  assessee company and  held that  the three  sums so  set apart by the assessee company  in its  balance-sheet were  not "reserves" and had to be excluded in the computation of its capital for the purpose  of levying  super profits  tax payable  on  the chargeable profits  tor the  relevant accounting year. It is this view  of the High Court that is being challenged by the assessee company in the Civil Appeal No. 86() of 1973 before us.      In Civil Appeal No. 1614/1978 (Ballarpur Industries Ltd ) and  Review Petition  No. 57  of 1980  (M/s. Bengal  Paper Mills Co. Ltd.) 798 We are  concerned with only two items of appropriation being (a) provision  for taxation  and (b)  provision for proposed dividend and  in each  one of  these cases the Calcutta High Court had  taken the  view  that  these  two  items  do  not constitute "reserves"  and as  such have to be ignored while computing the capital of the assessee company.      In Tax  Reference Case Nos. 2 and 3 of 1977 (M/s Echjay Industries  Pvt.  Ltd.)-a  case  under  Companies  (Profits) Surtax Act,  1964,  we  are  concerned  with  two  items  of appropriation being (a) provision for taxation (b) provision for proposed  dividend for  the two assessment years 1969-70 and 1970-71  and in each of the years the Taxing Authorities as also  the Income Tax Appellate Tribunal Bombay have taken the view that these appropriations did not constitute "other reserves" within  the  meaning  of  Rule  I  of  the  Second Schedule to  the Companies  (Profit) Surtax Act, 1954 and as such were  not includible  in the capital computation of the assessee company  but in  view of  a divergence  of  opinion between the different High Courts on the point, the Tribunal has at  the instance  of the  assessee company made a direct Reference to  this Court under s. 257 of the Income Tax Act,

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1961 read  with s. 18 of the Companies (Profits) Surtax Act, 1964.      In Tax  Reference Case  No. 5  of 1978  (Hyco  Products Pvt.Ltd.)-also a  case under Companies (Profits) Surtax Act, 1964 the same question pertaining to dividend alone but in a different form  arose for  consideration before  the  Taxing Authorities and  the Income  Tax Appellate  Tribunal. It was not a  case of  ’proposed dividend’ but the assessee company after transferring  Rs. 29,77,000  out of the current year’s profit amounting  to Rs. 61,03,382 to General Reserves, paid out of  Rs. 3,10,450  as dividend  to its share-holders from such augmented General Reserves and the question was whether while computing  the capital of the assessee-company for the purpose of  levy of  surtax the  General Reserves  should or should not be reduced by the aforesaid sum of Rs. 3,10,450 ? In other  words, the  question was whether the amount of Rs. 3,10,450 could  not form part of the General Reserves on the relevant date  (being 1.1.  1973) for the computation of the capital ?  The Taxing  Authorities as  well as the Appellate Tribunal Bombay  held that  the said  amount of Rs. 3,10,450 had to  be ignored for the purpose of computation of capital for surtax  purposes because  it  was  not  a  reserve.  The assessee company  has challenged  this view  of the Tribunal before us  in this direct Reference made to this Court under s. 257 of the 799 Income Tax  Act, 1961  read with  s. 18  of  the  Companies’ (Profits) A Surtax Act, 1964.      It  may   be  stated  that  the  scheme  and  the  main provisions  of  the  two  concerned  enactments  are  almost identical, the  object of  both these  enactments being  the imposition of  a special  tax on  excess profits  earned  by companies. Under  Section 4  of the  1963 Act,  which is the charging provision,  there shall be charged on every company for every  assessment year commencing on and from 1st April, 1963, a  tax, called the super profits tax, in respect of so much of  its "chargeable  profits" of  the previous  year as exceed  the  "standard  deduction"  at  the  rate  or  rates specified in  the Third  Schedule. Section  2(5) defines the expression "chargeable  profits" to mean the total income of an assessee computed under the Income Tax Act, 1961, for any previous year and adjusted in accordance with the provisions of First Schedule, while Section 2(9) defines the expression "standard deduction" to mean an amount equal to six per cent of the capital of company as computed in accordance with the provisions of  the Second  Schedule, or  an  amount  of  Rs. 50,000  whichever  is  greater.  In  order  to  D  determine "standard deduction" it becomes necessary to compute capital of the company in accordance with the rules laid down in the Second Schedule and rule 1 is relevant for our purposes, the material portion whereof runs as follows:      "1.  Subject to  the other provisions contained in this           Schedule, the  capital of  a company  shall be the           sum of  the amounts,  as on  the first  day of the           previous year  relevant to the assessment year, of           its paid  up share  capital and of its reserve, if           any, credited under the proviso (b) to Clause (vi-           b) of  sub-section (2!  of sec.  10 of  the Indian           Income Tax  Act, 1922  or under sub section (3) of           sec. 34  of the  Income Tax  Act, 1961, and of its           other reserves  in so  far as the amounts credited           to such  other reserves  have not  been allowed in           computing its  profits for  the  purposes  of  the           Indian Income Tax Act, 1922 or the Income Tax Act,           1961 .. "

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    It will be clear from the aforesaid provision of rule 1 that before  any amount  or sum  qualifies for  inclusion in capital computation of a company two conditions are required to be  fulfilled-(a) that  the  amount  or  sum  must  be  a "reserve" and  (b) the  same must  not have  been allowed in computing the company’s profits for the purposes of the 1922 Act or the 1961 Act. That none of the items 800 of appropriation  either  for  taxation  or  for  retirement gratuity,  or   for  proposed   dividend  in  the  concerned assessees’ case had been allowed in computing the assessee’s profits under  the 1961  Act has not been disputed; in other words  the   second  condition   indicated  above  has  been satisfied. The  question is whether any of these items could be  treated   as  or  falls  within  the  expression  "other reserves" occurring in the said rule.      The expression  ’reserve’ has  not been  defined in the Act and  therefore one  would be  inclined to  resort to its ordinary natural  meaning as  given in the dictionary but it seems to  us that  the dictionary  meaning, though useful in itself, may  not be sufficient, for, the dictionaries do not make any  distinction between the two concepts ’reserve’ and ’provision’ while  giving their  primary meanings whereas in the context  of the  legislation with which we are concerned in the  case a clear distinction between the two is implied. According to  the dictionaries (both oxford and Webster) the applicable primary  meaning of  the word  ’reserve’ is: "tc, keep for  future use  or enjoyment;  to set  apart for  some purpose or  end in  view; to  keep in  store for  future  or special  use;   to  keep   in  reserve",  while  ’provision’ according to Webster means: "something provided for future." In other words according to the dictionary meanings both the words are more or less synonymous and connote the same idea. Since the  rules for computation of capital contained in the Second Schedule  to the  Act proceed  on the  basis  of  the formula of  capital plus  reserves-a formula  well-known  in commercial accountancy,  it becomes  essential to  know  the exact  connotation   of  the   two  concepts  ’reserve’  and ’provision’ and  the distinction between the two as known in commercial  accountancy.   Besides,  though  the  expression ’reserve’ is  not defined in the Act, it cannot be forgotten that it  occurs in  a taxing  statute which is applicable to companies only  and to  no other  assessable entities and as such the  expression will  have  to  be  understood  in  its ordinary popular sense, that is to say, the sense or meaning that is  attributed to  it by  men of  business,  trade  and commerce and  by  persons  interested  in  or  dealing  with companies. Therefore,  the meanings  attached to  these  two words in  the provisions  of the  Companies Act 1956 dealing with  preparation  of  balance-sheet  and  profit  and  loss account would  govern their construction for the purposes of the two  taxing enactments.  We might  mention here  that in C.l.T. v.  Century Spinning  and Manufacturing  Company  (1) this Court after referring to the dictionary 801 meaning of  the expression  ’reserve’ observed: "what is the true A  nature  and  character  of  the  disputed  sum  (sum allegedly set  apart) must  be determined  with reference to the substance  of the  matter" and  went on to determine the true nature  and character  of the  disputed sum  by relying upon the  provisions of  the Indian  Companies Act 1913, the form and  the contents  of the balance-sheets required to be drawn up and Regulation 99 in Table A of the 1st Schedule.      The distinction  between the  two concepts of ’reserve’ and  ’provision’   is  fairly   well-known   in   commercial

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accountancy and the same has been explained by this Court in Metal Box Company of India Ltd. v. Their Workmen (1) thus:           "The distinction between a provision and a reserve      is in  commercial accountancy fairly well known. Provi-      sions made  against anticipated losses and contingencies      are charges  against profits and therefore, to be taken      into account  against gross  receipts in  the P. and L.      account and  the  balance-sheet.  On  the  other  hand,      reserves are  appropriations of  profits, the assets by      which they  are represented being retained to form part      of the capital employed in the business. Provisions are      usually shown in the balance sheet by way of deductions      from the  assets in  respect of  which  they  are  made      whereas general reserves and reserve funds are shown as      part of  the proprietor’s  interest.  (See  Spicer  and      Pegler’s Book-keeping  and Accounts, 15th Edition, page      42)". In other words the broad distinction between the two is that whereas a  provision is  a charge  against the profits to be taken into  account against  gross receipts  in the  P and L account, a reserve is an appropriation of profits, the asset or assets  by which it is represented being retained to form part of  the capital  employed in  the business.  Bearing in mind  the   aforesaid  broad  distinction  we  will  briefly indicate how  the two concepts are defined and dealt with by the Companies Act, 1956.      Under s. 210 of the Companies Act, 1956 it is incumbent upon the  Board of  Directors of every company to lay before the annual  general meeting  of its  share-holders  (a)  the annual balancesheet  and (b)  the profits  and loss  account pertaining to the previous 802 financial year.  Section 211(1) provides that every balance- sheet of  a company  shall give  a true and fair view of the state of  affairs of  the company  as  at  the  end  of  the financial year  and shall, subject to the provisions of this section, be in the form set out in Part I of Schedule VI, or near thereto as circumstances admit or in such other from as may be  approved by  the Central Government either generally or in  any particular  case, while  s. 211(2)  provides that every profit and loss account of a company shall give a true and fair  view of  the profit or loss of the company for the financial year  and shall, subject as aforesaid, comply with the requirements of Part Ir of r Schedule VI, so far as they are applicable  thereto. In  other words  the preparation of balance-sheet as  well as  profit and  loss account  in  the prescribed forms  and laying  the  same  before  the  share- holders  at   the  annual   general  meeting  are  statutory requirements which  the company  has to observe. The Form of balance-sheet as  given in  Part I  of Schedule  VI contains separate heads  of ’reserves  and  Surpluses’  and  ’current liabilities  and   provisions’  and   under   the   sub-head ’reserves’ different  kinds of  reserves are  indicated  and under sub-head  ’provisions’ different  types of  provisions are indicated; Part III is the interpretation clause setting out the  definitions of  various  expressions  occurring  in Parts I  and Il  and the  expressions ’reserve’, ’provision’ and ’liability’ have been defined in cl. 7 thereof. Material portion of cl. (7) of Part III runs as under:      "(1) For the  purposes of  Parts I and II of this Sche-      dule, unless the context otherwise requires:      (a)  the expression  "provision" shall, subject to sub.           cl. (2) of this clause mean any amount written off           or retained  by way of providing for depreciation,           renewals or  diminution in  value  of  assets,  or

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         retained  by   way  of  providing  for  any  known           liability of which the amount cannot be determined           with substantial accuracy:      (b)  the expression  "reserve" shall  not,  subject  as           aforesaid,  include  any  amount  written  off  or           retained by  way of  providing  for  depreciation,           renewals or  diminution  in  value  of  assets  or           retained  by   way  of  providing  for  any  known           liability;      (c)  x     x    x    x   x    x    x    x    x 803      and in this sub-clause the expression "liability" shall      include A  all liabilities  in respect  of  expenditure      contracted  for   and  all   disputed   or   contingent      liabilities.      (2)  Where-           (a)  any amount  written off or retained by way of                providing  for   depreciation,  renewals   or                diminution in  value of  assets, not being an                amount  written  off  in  relation  to  fixed                assets before  the commencement  of this Act;                or           (b)  any amount  retained by  way of providing for                any known liability,      is in excess of the amount which, in the opinion of the      directors, is reasonably necessary for the purpose, the      excess shall  be  treated  for  the  purposes  of  this      Schedule as a ’reserve’ and not a ’provision’."      On a plain reading of cl. 7(1) (a) and (b) and cl. 7(2) above it  will appear clear that though the term ’provision’ is defined  positively  by  specifying  what  it  means  the definition  of   ’reserve’  is  negative  in  form  and  not exhaustive in  the sense  that  it  only  specifies  certain amounts which  are not to be included in the term ’reserve’. In other  words the  effect of  reading the  two definitions together is  that if any retention or appropriation of a sum falls within the definition of ’provision’ it can never be a reserve but  it does  not follow  that if  the retention  or appropriation is  not a  provision  it  is  automatically  a reserve and  the question  will have  to be  decided  having regard to  the true  nature and  character  of  the  sum  so retained  or   appropriated  depending  on  several  factors including the intention with which and the purpose for which such retention  or appropriation  has been  made because the substance of  the matter  is to  be  regarded  and  in  this context the primary dictionary meaning of the term ’reserve’ may have to be availed of. But it is clear beyond doubt that if  any  retention  or  appreciation  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 assessees strenuously contended before  us that  once it was shown or became clear that the retention or appreciation of a sum out of 804      profits and  surpluses was  for an unknown liability or for a  liability which did not exist on the relevant date it must be  regarded as  a reserve.  The fallacy underlying the contention  becomes   apparent  if  the  negative  and  non- exhaustive aspects of the definition of reserve are borne in mind. Having  regard to  type  of  definitions  of  the  two concepts which  are to  be found  in cl.  7 of Part. III the proper approach  in our  view, would  be first  to ascertain whether the  particular retention  or appropriation of a sum

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falls within  the expression ’provision’ and if it does then clearly the  concerned sum will have to be excluded from the computation of  a 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.      Having  thus   indicated  the  proper  approach  to  be adopted, we  shall proceed  to deal  with the three items of appropriation  being   (a)  provision   for  taxation,   (b) provision for  retirement gratuity  and  (c)  provision  for proposed  dividends   in  the  case  of  concerned  assessee companies in these Appeals and Tax Reference Cases.      Dealing first  with the item of appropriation by way of provision for  taxation, which  arises in  Civil Appeal  No. 860/1973 (Vazir  Sultan Tobacco  Company), Civil  Appeal No. 1614 (NT)/  1978 (Ballarpur Industries Ltd;) Review Petition No. 50/1980  (M/s. Bengal  Paper Mills  Co.  Ltd.)  and  Tax Reference Cases  Nos. 2 & 3/1977 (M/s Echjay Industries Pvt. Ltd;)-the common  question is  whether the concerned amounts appropriated or  set apart  by these assessee-companies from out of  the profits  and other  surpluses by  way of  making provision for  taxation constitute  a provision or a reserve on the  relevant date,  being the  first day of the previous year relevant  to the  assessment year  in question ? Taking Vazir Sultan  Tobacco Company’s case as an illustration, for the assessment  year 1963-64  the relevant accounting period was the year which ended on September 30, 1962; under Rule I of the  Second Schedule  to the  Super Profits  Tax Act, the first day of the previous year would be october 1, 1961 and. therefore, the balance-sheet of that company as on September 30, 1961  and the  profits and  loss account  which ended on September 30,  1961 would be relevant. It cannot be disputed that on  the expiry  of September  30,  1961,  the  assessee company incurred  the taxation  liability in  respect of the profits 805 which it  had earned  during that  year,  though  the  exact amount of  such  liability  could  not  be  determined  with substantial accuracy at that time and the same would have to be ascertained  by reference  to rate of taxes applicable to that year.  The liability for taxation having thus arisen on the expiry of the last day of the year, the setting apart of the sum of Rs. 33,68,360 by the Board of Directors will have to be  regarded as  a provision  for a  known  and  existing liability, the  quantification whereof bad to be done later. On principle,  therefore, it seems to us clear that the item of Rs.  33,68,360 which  had been  set apart by the Board of Directors for  taxation must  be regarded as a provision and cannot be  regarded as  a  reserve.  Similar  would  be  the position in  regard to  the appropriations for taxation made by the other assessee-companies mentioned earlier.      In this context a reference to this Court’s decision in the case  of Kesoram  Industries and  Cotton Mills  Ltd.  v. Commissioner of  Wealth Tax  (Central) Calcutta(’)  would be useful. In  that case  the question  was whether  a  certain amount which  had been set apart as provision for payment of income-tax and  super tax  was  a  "debt  owed"  within  the meaning of  s. 2(m) of the Wealth-Tax Act, 1957, as on March 31, 1957  which was  the valuation  date  and  as  such  was deductible in  computing the  net wealth  of  the  appellant company. In  its balance-sheet for the year ending March 31, 1957 the  appellant company  had shown  a certain  amount as

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provision for payment of income-tax and super-tax in respect of that  year of  account and  this Court took the view that the expression  "debt owed" within the meaning of s. 2(m) of the Wealth-Tax  Act, 1957  could be defined as the liability to pay  in presenti  or in  futuro an  ascertainable sum  of money and that the liability to pay income-tax was a present liability  though  the  tax  became  payable  after  it  was quantified in accordance with ascertainable data; that there was a perfected debt on the last date of the accounting year and not  a contingent  liability. The Court further observed that the  rate was  always easily ascertainable; that if the Finance Act  was passed,  it was the rate fixed by that Act; if the  Finance Act  was not  yet passed,  it was  the  rate proposed in  the Finance  Bill pending before the Parliament or the  rate in  force in  the preceding  year whichever was more favourable to the assessee and that all the ingredients of a  "debt" were  present and it was a present liability of an ascertainable  amount and  that, therefore, the amount of provision for payment of income-tax and super-tax in respect of the year of account ending March 31, 1957 was a "debt H 806 owed" within  the meaning  of s. 2(m) on the valuation date, namely  March  31,  1957  and  was  as  such  deductible  in computing the net wealth. The ratio of this decision clearly suggests that  the appropriation of the amounts set apart by the  assessee   companies  before   us  for  taxation  would constitute a  provision made  by them  to meet  a known  and existing liability  and as  such the concerned amounts would not be includible i n capital computation.      Counsel  for  the  assessee  company  in  Vazir  Sultan Tobacco  Company’s  case,  however,  attempted  to  raise  a further plea  that the  provision for taxation in the sum of Rs. 33,68,360 was an excess provision in the sense it was in excess of  the amount which was reasonably necessary for the purpose of  taxation and,  there ore,  the excess  should be treated as  a reserve and not a provision and in this behalf reliance was  placed on  cl. (7) (2) of Part III of Schedule VT and three decisions-of the Madras High Court Commissioner of Income-tax  Madras v.  Indian Steel Rolling Mills Ltd.(l) of the  Himachal Pradesh High Court in Hotz Hotels Pvt. Ltd. v. Commissioner  of Income  Tax, Haryana,  H.P. and Delhi(2) and of  Allahabad High  Court in Commissioner of Income-Tax, Delhi v.  Modi Spinning and Weaving Mills(3). There could be no dispute about the principle that if provision for a known or existing  liability is  made in excess of the amount that would be reasonably necessary for the purpose 13: the excess shall have  to be treated as a reserve and, therefore, would be includible  in the  capital computation  but no such case was made  out by  the assessee  company at  any stage of the assessment proceedings  either before the Taxing Authorities or even  before the  Tribunal or  the High  Court and in the absence of  any such plea having been raised at any stage of the proceedings  it will  not be  proper for  this Court  to allow the  assessee company to raise such a plea, which will need investigation  into facts,  for the  first time  in its appeal before  this Court.  The  contention  is,  therefore, rejected. Dealing  next with  the item of appropriation made for retirement  gratuity, which  arises only in Civil Appeal No. 860/1973  (Vazir Sultan  Tobacco Co.)  the  question  is whether the sum of Rs. 9,O8,106 appropriated or set apart by the assessee  company from  out of  its  profits  and  other surpluses by  way of  providing for retirement gratuity is a provision or a reserve on the relevant date, 807 viz. 1.10.1961 ? Counsel for the assessee-compaoy vehemently

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urged before us that this appropriation had not been allowed as a  deduction in  the income-tax assessment proceedings of the company  for the  relevant assessment year on the ground that it  was in  the nature of a reserve and the entire sum, minus the  actual payments, was added back to the income and profits of  the assessee-company  and if  that be so, in the super profit-tax  assessment  it  cannot  be  treated  as  a provision and  excluded from  capital computation. According to him  there could  not be two different treatments for the same item  in income-tax  assessment and  super  profit  tax assessment.  He   pointed  out   that  this  contention  was specifically  urged  in  the  appeal  before  the  Appellate Assistant Commissioner  but was wrongly rejected. He further submitted that  no actuarial  valuation had been undertaking but ad hoc amount was appropriate or transferred to gratuity reserve and  as such  the same should have been treated as a reserve and  included in  capital computation.  On the other hand, counsel  for the  Revenue seriously  disputed the last submission and  contended that  it was never the case of the assessee-company either  before the  Taxing  Authorities  or before the  Tribunal or  before  the  High  Court  that  the appropriation was  or an  ad hoc sum without undertaking any actuarial valuation.  It must  be observed  that whereas the assessee-company did  urge a  contention  before  the  lower authorities that  different treatments  for  the  same  item could not  be given for purpose of income-tax assessment and super profit-tax  assessment, the  assessee company  did not clarify by  placing material  on record  as to  whether  the appropriation of  the amount  was  based  on  any  actuarial valuation or  whether it  was an  appropriation of an ad hoc amount an aspect which, as we shall presently point out, has a vital  bearing on  the question  whether the appropriation could be treated as a provision or a reserve. In the absence of proper  material  touching  this  vital  aspect,  we  are afraid, the  issue in  question will  have to be remanded to the Taxing  Authorities through the Tribunal for disposal in the light  of the  well settled  principles in  that behalf, which we shall presently indicate.      Ordinarily an  appropriation to  gratuity reserve  will have to  be regarded  as a  provision made  for a contingent liability, for,  under a  scheme framed  by  a  company  the liability to  pay gratuity to its employees on determination of employment  arises  only  when  the  employment.  Of  the employee is  determined by  death, incapacity, retirement or resignation-an event  (cessation of  employment) Certain  to happen in  the service  career of  every employee; moreover, the amount  of gratuity  payable is usually dependent on the emp- 808 loyee’s wages at the time of determination of his employment and the  number of  years of  service put  in by him and the liability accrues and enhances with completion of every year of service;  but the  company can  work out  on an actuarial valuation its  estimated liability  (i.e. discounted present value of  the liability  under the  scheme on  a  scientific basis) and  make a  provision for  such liability not all at once but  spread over a number of years. It is clear that if by adopting such scientific method any appropriation is made such appropriation  will constitute a provision representing fairly accurately  a known  and existing  liability for  the year in question; if, however, an ad hoc sum is appropriated without resorting to any scientific basis such appropriation would  also   be  a  provision  intended  to  meet  a  known liability, though  a contingent  one,  for,  the  expression ’liability’ occurring  in cl. (7) (1) (a) of Part III of the

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Sixth Schedule to the Companies Act includes any expenditure contracted for and arising under a contingent liability; but if the  sum so  appropriated is shown to be in excess of the sum required  to meet  the estimated  liability  (discounted present value  on a  scientific basis) it is only the excess that will have to be regarded as a reserve under cl. (7) (2) of Part III to the Sixth Schedule.      In the above context we might refer to one English case decided by  the House of Lords and two or three decisions of this Court, which seem to lead to aforesaid propositions. In Southern Railway  of Peru Ltd. v. Owen(1) an English Company operating a  railway in  Peru was,  under the  laws of  that country, liable  to pay  its employees  conpensation on  the termination of  their services  either by  dismissal  or  by notice  or  on  such  termination  by  death  or  efflux  of contractual time.  The compensation  so paid  was an  amount equivalent to one month’s salary at the rate in force at the date of  determination for  every year  of service.  In  the computation of taxable income under the Income-tax Act 1918, the company  claimed to  be entitled  to charge against each year’s  receipts  the  cost  of  making  provision  for  the retirement payments  which would ultimately be thrown on it, calculating the  sum required to be paid to each employee if he retired  without forfeiture  at the close of the year and (; setting  aside the  aggregate of  what was required in so far as  the year had contributed to the aggregate. The House of Lords  rejected the  deductions on  the  ground  that  in calculating the  deductions  the  company  had  ignored  the factor of  discount. But,  their  Lordships  recognised  the principle that  the company  was entitled to charge, against each year’s receipts, the cost of making the 809 provision for  the  retirement  which  would  ultimately  be payable as  the company  had the  benefit of  the employee’s services during  that year provided the present value of the future payments  could be  fairly estimated. Lord MacDermott observed at page 345 as follows:           ".... as  a general  proposition it  is,  I  think      right to say that, in computing his taxable profits for      a particular  year, B a trader, who is under a definite      obligation to  pay his  employees for their services in      that year  an  immediate  payment  and  also  a  future      payment in  some subsequent  year, may properly deduct,      not only the immediate payment but the present value of      the future  payment, provided such present value can be      satisfactorily determined or fairly estimated."      In Standard  Mills Co.  Ltd. v. Commissioner of Wealth- Tax, Bombay  (1) the  question for  decision was  whether an estimated liability  under  gratuity  schemes  framed  under industrial awards  amounted to ’debts’ and could be deducted while computing the net wealth of the assessee-company under the Wealth  Tax Act. This Court held in view of the terms of s. 2  (m) of that Act, that as the liability lo pay gratuity was  not   in  praesenti   but  would  arise  in  future  on determination of the service, i. e. On the retirement, death or termination,  the estimated  liability under  the schemes would not  be a ’debt’ and, therefore, could not be deducted while computing  the net wealth. The House of Lords decision in the  case of  Southern Rly.  Of  Peru  Ltd.  (supra)  was distinguished by  this Court  as having  no relevance to the question before  it on the ground that the House of Lords in that decision was concerned in determining the deductibility of the  present value  of a  liability which  may  arise  in future in the computation of taxable income for the relevant year under  the income-tax  laws. It  will thus  appear that

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this Court was of the view that though such a liability is a contingent liability  and, therefore,  not a ’debt’ under s. 2(m) of  the Wealth-Tax Act it would be deductible under the Income Tax Act while computing the taxable profits; in other words different  considerations would apply to cases arising under the Wealth-Tax Act and the Income-Tax Act.      In Matal Box Co’s case (supra) this Court was concerned with the  nature of  liability under a scheme of gratuity in the context  of the  Payment of  Bonus  Act,  1965  and  the question related to a sum 810 of Rs.  18.38 lakhs  being the estimated liability under the two gratuity  schemes  framed  by  the  company,  which  was deducted from  the gross  receipts in  the P & L Account, it being contended on behalf of the workmen that such deduction was not  justified while determining the ’available surplus’ and the  ’allocable surplus’  for payment  of bonus  to them under the Payment of Bonus Act, 1965. The Court rejected the contention and  adverting to  the decision of House of Lords in the  case of Southern Rly. Of Peru Ltd. (supra) held that an estimated  liability under  gratuity schemes  even if  it amounted to  a contingent  liability and  was not  a  ’debt’ under the  Wealth Tax Act, if properly ascertainable and its present value  was fairly discounted was deductible from the gross-receipts while  preparing  the  P  &  L  Account.  The material portion  of the  head-note appearing  at page 54 of the report runs thus:           "Contingent liabilities  discounted and  valued as      necessary,  can   be  taken  into  account  as  trading      expenses if they are sufficiently certain to be capable      of  valuation   and  if   profits  cannot  be  properly      estimated without  taking them  into consideration.  An      estimated liability  under  a  scheme  of  gratuity  if      properly  ascertainable   and  its   present  value  is      discounted, is deductible from the gross receipts while      pre paring  the P  & L  account. This  is recognised in      trade circles  and there  is nothing  in the  Bonus Act      which prohibits  such  a  practice.  Such  a  provision      provides for  a known liability of which the amount can      be determined  with substantial  accuracy.  It  cannot,      therefore,  be   termed  a  "reserve".  Therefore,  the      estimated liability for the year on account of a scheme      of gratuity  should be  allowed to be deducted from the      gross profits.  The allowance  is not restricted to the      actual payment of gratuity during the year." At page 62 of the Report this Court observed thus:           "Two questions,  therefore, arise:  (I) whether it      is legitimate  in such a scheme of gratuity to estimate      the liability on an actuarial valuation and deduct such      estimated liability  in the P & L Alc while working out      its  net   profits;  (2)  if  it  is,  b  whether  such      appropriation amounts to a reserve or a provision?.. In      the case  of an  assessee maintaining  his accounts  on      mercantile system,  a liability already accrued, though      to be  discharged at  a future  date, would be a proper      deduction while  working out  the profits  and gains of      his business, re- 811      gard being  had to the accepted principle of commercial      A practice  and accountancy  . It  is not  as  if  such      deduction  is  permissible  only  in  case  of  amounts      actually expended or paid. Just as receipts, though not      actual receipts  but accrued  due, are  brought in  for      income-tax assessment,  so also liabilities accrued due      would be  taken into  account  while  working  out  the

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    profits and gains of the business". Again at page 64 of the Report this Court observed thus:           "In the  instant case  the question is not whether      such estimated  liability arising  under  the  gratuity      schemes amounts  to a  debt or  not. The  question that      concerns us  is  whether  while  working  out  the  net      profits, a  trader can pro vide from his gross receipts      his liability to pay a certain sum for every additional      year of  service which  he receives from his employees.      This, in  our view,  he can  do if  such  liability  is      properly ascertainable  and it is possible to arrive at      a proper  discounted  present  value.  Even  if  the  n      liability  is  a  contingent  liability,  provided  its      discounted present  value is  ascertainable, it  can be      taken into  account. Contingent  liabilities discounted      and valued  as necessary  can be  taken into account as      trading expenses if they are sufficiently certain to be      capable of  valuation and if profits cannot be properly      estimated without taking them into account."      In the  case of Workmen of William Jacks . Co. Ltd. v. Management of  Jacks &  Co. Ltd. Madras (1) another decision under the  Payments of  Bonus Act,  1965, this  Court, after referring to  the distinction  pointed out in Metal Box Co’s case between  the two concepts ’provision’ and ’reserve’ has observed on page 547 as follows:           "The  provision  for  gratuity,  furlough  salary,      passage, service  and commission,  in the  present case      was  all   made  in   respect  of  existing  and  known      liabilities though  in some  cases the amount could not      be ascertained  with accuracy.  It was not a case where      it was  an anticipated  loss or anticipated expenditure      which  would   arise  in   future.  Such  provision  is      therefore not a reserve at all and cannot be added back      under item 2 (c) of the Second Schedule." 812      In the above case also the Court was concerned with the question whether  particular provision  made  for  gratuity, furlough salary,  passage, etc. was a reserve or a provision for the  purpose of  Second Schedule to the Payment of Bonus Act,  1965.  At  page  546  of  the  report  the  Court  has categorically  observed   that  all   these  items,  namely, gratuity furlough salary, passage, service, commission, etc. were clearly  in respect  of liabilities  which had  already accrued in  the years  in which  the provision  was made and were not  in respect  of anticipated liabilities which might arise in future and, therefore, the Court held that the said provision was not a reserve but a provision.      From the  aforesaid discussion of the case law it seems to us  clear that  the propositions  indicated by us earlier clearly  emerge.   Since  in  the  instant  case  sufficient material throwing light on the above aspects of the question has not  been made  available, we  think, it  will be in the interest of  justice to remand the case through the Tribunal to the taxing authority to decide the issue whether the con- cerned amount  (Rs. 9,O8,1061-) set apart and transferred to gratuity reserve  by  the  assessee  company  was  either  a provision or a reserve and if the latter to what extent? The taxing authority will decide the issue in light of the above principles after  giving  an  opportunity  to  the  assessee company to place additional relevant materials before      Turning to  the last  item of  appropriation by  way of provision for  proposed dividends, which arises in all these matters (except  in Tax  Reference Case  No. 511978  of Hyco Products Pvt.  Ltd.) the  common  question  is  whether  the concerned amount  appropriated or set apart by the assessee-

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companies from out of the profits and other surpluses by way of making  provision for  ’proposed dividends’ constituted a provision or a reserve on the relevant date ?      It is  true that under s. 27 of the Companies Act, 1956 the Directors  can merely  recommend that  a certain  sum be paid as  dividend but such recommendation does not result in any obligation  or liability; the obligation or liability to pay the  dividend arises  only when the share-holders at the annual general  meeting of  the company decide to accept the recommendation and  pass a resolution for declaration of the dividend. It  is therefore open to the directors to withdraw or modify  their  recommendation  at  any  time  before  the shareholders accept  the same  and it is equally open to the shareholders not  to accept  the recommendation at all or to declare a dividend of an amount lesser than that recommended by directors. In Kesoram 813 Industries  case   (supra)  this  Court  has  clarified  the aforesaid legal  A position  by observing at page 772 of the report, thus:           "The directors  cannot  distribute  dividends  but      they can  only recommend  to the  general body  of  the      company the  quantum of  dividend  to  be  distributed.      Under section  217 of  the Indian  Companies Act, there      shall be  attached to every balance-sheet laid before a      company in  general meeting  a report  by its  board of      directors with  respect to,  interalia, the  amount, if      any, which it recommends to be paid by way of dividend.      Till the  company in  its general  body meeting accepts      the  recommendation  and  declares  the  dividend,  the      report of  the directors  in  that  regard  is  only  a      recommendation which  may be  withdrawn or  modified as      the case  may be.  As on  the valuation date (under the      Wealth Tax  Act) nothing  further happened  than a mere      recommendation by  the directors  as to the amount that      might be distributed as dividend, it is not possible to      hold that  there was  any debt  owed by the assessee to      the share holders on the valuation date."      All that  follows from  above is  that in  the  instant cases the  appropriations of  the concerned  amounts by  the Board of Directors by way of providing for proposed dividend would not  constitute ’provisions’  for, the  appropriations cannot be  said to  be by  way of providing for any known or existing liability,  none having arisen on the date when the directors made  the recommendation much less on the relevant date being  the first  day of  the previous year relevant to the assessment  year in question. But as stated earlier this by itself  would not automatically convert the appropriation into ’reserves’,  regard being  had to the negative and non- exhaustive character of the definition of ’reserve’ given in cl. 7  (I)(b) of  Part III  of the  Sixth  Schedule  to  the Companies A  ct. The  question whether the concerned amounts in fact  constituted ’reserves’  or  not  will  have  to  be decided by having regard to the true nature and character of the  sums  so  appropriated  depending  on  the  surrounding circumstances particularly  the intention with which and the purpose for which such appropriations had been made.      We  have   already  indicated  that  according  to  the dictionaries  (both   oxford  and  Webster)  the  applicable meaning of the word ’reserve’ is: "to keep for future use or enjoyment; to  set apart for some purpose or end in view; to keep in store for future or special 814 use; to keep in reserve." In other words, the word ’reserve’ as a  noun in  ordinary parlance would mean "something which

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is kept  for future  use or  stored up  for something or set apart for  some purpose".  It  cannot  be  disputed  that  a reserve may be a general reserve or specific reserve and all that is  required is that an amount should be kept apart for some purpose,  either general  or  specific.  Eeven  so  the question is  whether the earmarking of a portion of pro fits by the  board of  directors of  a company  avowedly for  the purpose of  distributing  dividend  would  fall  within  the expression ’reserve’  occurring in  rule  T  of  the  Second Schedule to  the Super  Profits  Tax  Act,  1963?  For  this purpose certain  tests indicated  in some  decisions of this Court will have to be considered: The first decision of this Court in that behalf is the decision in Century Spinning and Manufacturing Company’s  ease  (supra).  In  that  case  the material  facts   were  these:  For  the  year  ending  31st December, 1946,  the profit  of the  assessee-company, whose accounting year  was the  calendar year,  was a  certain sum according to  the profit  and  loss  account.  After  making provision for  depreciation and taxation, the balance of Rs. 5,08,637 was  carried to the balance sheet. This sum was not allowed in  computing the  profits of  the assessee  for the purposes of income tax. On 28th February, 1946, the Board of directors recommended  out of  that amount  the sum  of  Rs. 4,92,426 should  be distributed  as dividend and the balance of Rs.  16,211 was  to be carried forward to the next year’s account. This  recommendation was  accepted  by  the  share- holders in  their meeting on 3rd April, 1946, and the amount was shortly afterwards distributed as dividend. In computing the capital  of the  assessee company  on 1st  April,  1946, under the  Business Profits  Tax  Act,  1947,  the  assessee claimed that  the sum  of Rs. 5,08,637 and the profit earned by it  during the  period 1st  January, 1946  to 1st  April, 1946, should  be treated  as "reserves"  for the  purpose of rule 2(1)  of Schedule  IT. The High Court held that the sum of Rs. 5,08,637 must be treated as a reserve for the purpose of rule  2, but  the profit made by the assessees during the period 1st  January, 1946  to 1st  April, 1946  could not be included in  the reserves.  On appeal  to this Court, it was held that  the sum  of Rs.  5,08,637 as  well as the profits earned by  the assessee  during the period 1st January, 1946 to 1st  April, 1946 did not constitute "reserves" within the meaning of  rule 2 (1) of Schedule II. After noting that the expression ’reserve’  had not  been defined  in the Business Profits Tax  Act, 1947  and after noting dictionary meanings of that expression the Court observed: 815           " What  is the  true nature  and character  of the      disputed A sum must be determined with reference to the      substance of the matter and when this is borne in mind,      it follows  that the  1st of  April, 1946  which is the      crucial date,  the sum  of Rs.  5,08,637 could  not  be      called a  reserve for nobody possessed of the requisite      authority had  indicated on  that date  the  manner  of      disposal or  distination. On  the other  hand, B on the      28th February,  1946 the directors clearly earmarked it      for distribution  as dividend  and did  not make  it  a      reserve. Nor  did the  company in  its meeting  of  3rd      April, 1946  decide that  it was a reserve. It remained      on the 1st of April, as a mass of undistributed profits      which were available for distribution and not earmarked      as "reserve".  On the  1st of  January, 1946 the amount      was simply  brought from the profit and loss account to      the next  year and  nobody with  any authority  on that      date made  or declared  a reserve. The reserve may be a      general reserve  or a  specific reserve, but there must

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    be a  clear indication to show whether it was a reserve      either of  the one  or the other kind. The fact that it      constituted a  mass of undistributed profits on the 1st      Jan. 1946  cannot automatically  make it  a reserve. On      the 1st  April, 1946  which is  the commencement of the      chargeable  accounting   year,  there   was  merely   a      recommendation by  the directors  that  the  amount  in      question should  be distributed  as dividend.  Far from      showing that  the directors  have made  the  amount  in      question a  reserve it  shows that  they had decided to      earmark it for distribution as dividend."      The decision clearly lays down that the true nature and character of  the  appropriation  must  be  determined  with reference to  the substance  of the  matter; obviously  this means that  one must have regard to the intention with which and the  purpose for which appropriation has been made, such intention and  purpose being  gathered from  the surrounding circumstances.  In   that  behalf   the  following   aspects mentioned in  the judgment  provide some  guidelines: (a)  a mass of  undistributed profits cannot automatically become a reserve and that somebody possessing the requisite authority must clearly  indicate  that  a  portion  thereof  has  been earmarked or separated from the general mass of profits with a view  to constituting  it either  a general  reserve or  a specific reserve,  (b) the  surrounding circumstances should make it  apparent that the amount so ear-marked or set apart is in fact a reserve to be utilised in future for a specific purpose and  on a specific occasion, and (c) a clear conduct on the 816 part of the directors in setting apart a sum from out of the mass of  undistributed profits  avowedly for  the purpose of distribution as  dividend in the same year would run counter to any  intention of  making that  amount a  reserve. It was because these  aspects obtained  in the case that this Court took the  view that  neither the sum of Rs. 5,08,637 nor the profits  earned  by  the  assessee  during  the  period  1st January, 1946 to 1st April 1946 constituted "reserve" within the meaning  of Rule 2(1) of Second Schedule of the Business Profits Tax Act, 1947.      Two more  decisions of this Court one in First National City Bank v. Commissioner of Income-Tax (1) and the other in Commissioner of  Income-Tax (Central),  Calcutta v. Standard Vacuum oil Co.(2) which provide two more guidelines, may now be considered.  In both  these cases the Court was concerned with the question whether the amount set apart as "undivided profit" or  set apart as "earned surplus" in accordance with the system  of accountancy  which  obtained  in  the  United States amounted  to a  reserve liable  to be included in the capital computation  under rule  2 of  Schedule  II  of  the Business Profits  Tax Act,  1947.  In  both  the  cases  the assessees  were  non-resident  companies  and  followed  the system  of   accounting  that   obtained  in   the  American commercial world.  In the first case Justice Kapur, speaking for the  court, pointed  out the  difference between the two system of accounting at Page 23 of the Report thus:           "In India  at the  end of  an year  of account the      unallocated profit  or loss  is carried  forward to the      account of  the next  year, and such unallocated amount      gets merged  in the account of that year. In the system      of accounting  in the  USA each year’s account is self-      contained and  nothing is  carried forward.  If afteral      locating the  profits to  diverse heads mentioned above      any balance  remains, it  is credited to the "undivided      profits" which  become part  of the capital fund. If in

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    any year  as a  result of  the allocation there is loss      the accumulated undivided profits of the previous years      are drawn  upon and  if  that  fund  is  exhausted  the      banking company  draws upon  the surplus.  In its  very      nature  the   undivided  profits  are  accumulation  of      amounts of  residue on  hand at  the end of the year of      successive periods  of accounting and these amounts are      by the  prevailing accounting practice and the Treasury      directions regarded  as a  part of  the capital fund of      the banking company.’ 817      After quoting with approval the above observations, Mr. A Justice  Shah in Standard Vacuum Oil Co.’s case went on to observe at page 695 of the report as follows:           "It is  true that  the  court  in  that  case  was      dealing with  a case  of  a  banking  company  but  the      characteristics noted  are not peculiar to the accounts      of  a   banking  company;   they  are  applicable  with      appropriate variations to the accounts of all companies      in  which  different  nomenclatures  are  used  in  the      accounts to designate the residue on hand as ’surplus’,      ’ undivided profits’ or ’earned surplus’.           Where the  balance of net profits after allocation      to  specific  reserves  and  payment  of  dividend  are      entered  in  the  account  under  the  caption  ’earned      surplus’, it  is intended thereby to designate the fund      which is to be utilised for the purpose of the business      of the  assessee. Such a fund may be regarded according      to the Indian practice as ’general reserve") This Court in the first case held that the amount designated as "undivided  profits" which  was available  for continuous future use  of the  business for  the bank was a part of the reserve and had to be taken into account while computing the capital under  rule 2(1)  of Schedule  II  of  the  Business Profits Tax  Act; similarly,  in the  second case  the Court held that  the amount  which had  been allocated  to "earned surplus" which  was intended for the purpose of the business of the  assessee company and was used in subsequent years in business, represented ’’reserves" within the meaning of rule 2 of  Schedule II  of the  Business Profits: Tax. From these two decisions  two aspects emerge very clearly. In the first place, the  nomenclature accorded  to  any  particular  fund which is  set apart  from out  of the  profits would  not be material or  decisive of  the matter  and  secondly,  having regard to  the purpose  of rule  of 2  of Schedule II of the Business Profits Tax Act, 1947, if any amount set apart from out of  the profits  is going to make up capital fund of the assessee and  would be  available to  the assessee  for  its business purposes,  it would  become a  reserve liable to be included in  the capital  computation of  the assessee under that Act.      The provisions  of the  Companies Act  1956  also  lend support  to   the  proposition  that  an  appropriation  for proposed dividend  would not  amount to  a reserve.  Section 217(1) runs thus: 818           "217(1) There  shall be  attached to every balance      sheet laid  before a  company  in  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,           (c)  the amounts,  if  any,  which  it  recommends                should be paid by way of dividend;           (d)  ................................. "

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Regulation 87 of Table A in the First Schedule runs thus:           "87(1) The  Board  may,  before  recommending  any      dividend, set  aside out  of the profits of the company      such sums  as it thinks proper as a reserve or reserves      which  shall,  at  the  discretion  of  the  Board,  be      applicable for  any purpose to which the profits of the      company may  be properly  applied, including  provision      for meeting  contingencies or for equalising dividends;      and  pending   such  application   may  at   the   like      discretion, either  be employed  in the business of the      company or  be invested in such investments (other than      shares of  the company)  as the Board may, from time to      time, think fit.           (2)  The Board  may also carry forward any profits           which it  may think prudent not to divide, without           setting them aside as a reserve." The aforesaid  provisions read  together clearly  show  that creating re serves out of the profits is a stage distinct in point of  fact and anterior in point of time to the stage of making recommendation for payment of dividend and the scheme of the  provisions suggests  that appropriation  made by the Board of  Directors by  way of  recommending  a  payment  of dividend cannot in the nature of things be a reserve.      If regard  be had to the guide-lines indicated above as well as  the provisions  of the Companies Act 1956 specified above we  are clearly  of the opinion that the appropiations made by  the directors  for proposed dividend in the case of the   concerned   assessee-companies   do   not   constitute ’reserves’ and the concerned amounts so set apart would have to be ignored or excluded from capital computation. 819      Since we have reached the aforesaid conclusion on first principles and  on the  basis of  the  guidelines  discussed above it  is unnecessary  for us  to go  into or discuss the scope and  effect of  the Explanation  to Rule  1 in  Second Schedule to The Companies (Profits) Sur-tax Act, 1964 though it seems  to us  prime facie  that  the  Explanation,  being clarifacatory in nature is declaratory of the existing legal position.      Dealing with  the last  case of Hyco Products Pvt. Ltd. Bombay (Tax  Reference  Case  No.  5  of  1978),  where  the question pertaining  to dividend  but in  a  different  form arises for  consideration, the admitted facts may briefly be stated. The question relates to the Assessment Year 1974-75, the relevant  previous year being calendar year 1973 and the material date  being 1.1.1973.  After the  accounts  of  the calendar year  1972 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 tranfer the General Reserve of the assessee company as on 1.1.1973 stood at Rs.  86,07,712. At  the end  of the  calendar year,  1973 admittedly the  directors did  not make  any  provision  for ’proposed dividend’  in its  accounts but  there was note on the Balance Sheets to the following effect:-           "The directors  have recommended  dividend for the      year 1972  at the  rate of  Rs. 10/-  per share free of      tax. The  dividend, if approved by the share-holders at      the forth-  coming Annual General Meeting, will be paid      out of  General Reserve  and no  separate provision has      been made therefor in the accounts." At the Annual General Meeting held on June 30, 1973 dividend of Rs.  3,10,450 was  declared by  the share-holders and the same was  soon thereafter  paid  out  of  the  said  General Reserve. In the surtax assessment proceedings under the 1964 Act the  assessee claimed  that the  entire general  reserve

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which stood  as Rs. 86,07,712 as on 1.1.1973 should be taken into account  while computing  the capital  of the  assessee company. But the taxing officer reduced the general reserves by the aforesaid sum of Rs. 3,10,450 and only the balance of Rs. 82,97,262  was  added  in  computing  the  capital.  The Appellate Assistant  Commissioner as  well as the Income-Tax Appellate Tribunal, Bombay confirmed the order of the Taxing officer. The Tribunal took the view that though it was not a case of ’pro- posed dividend’ since the amount actually paid out  as   dividend  was   a  smaller  sum  than  the  amount transferred from out of profits to 820 the General  Reserve that  amount could not form part of the reserve and  therefore the General Reserve as reduced by Rs. 3,10,450 was  properly taken into account for the purpose of computation of  the capital  as on the relevant date. At the instance of  the assessee  the  Tribunal  has  referred  the following question  of law  directly to  this Court  for its opinion under s. 257 of the Income Tax Act 1961 read with s. 18 of the Companies (Profits) Sur-tax Act, 1964:           "Whether on  the facts and in the circumstances of      the case  the Tribunal was justified in excluding a sum      of Rs. 3,10,450 representing the dividends declared for      the calendar year 1972 from the General Reserves on the      opening date  of the  previous year while computing the      capital under  the Second  Schedule  of  the  Companies      (Profits) Sur-tax  Act, 1964  for the  assessment  year      1974-75?"      Counsel for  the assessee-company  contended that after con ceding  that this  was not a case of "proposed dividend" the Tribunal  erred in  holding that  the sum of Rs 3,10,450 representing the dividends paid out from the General Reserve was liable to be excluded while computing the capital of the company as  on 1.1.1973  for purposes  of sur-tax assessment under the  1964 Act. According to him under s. 205(1) of the Companies Act,  1956 dividend  can be  paid from  out of the current year’s  profits or profits of any previous financial year or  years and  there is  no presumption  in law  or  in commercial accounting  that a dividend has to be paid either from the  current year’s  profits or  from the  past year’ s profits. He  further urged that once from out of the current year’s profit   a  certain sum is transferred to the General Reserve it merges into the latter and the General Reserve so augmented becomes  a conglomerate  fund and  if out  of such conglomerate fund  any sum  is recommended  or paid  out  as dividend it  will be  difficult to say that such payment has come out  of the  portion of current year’s profits that has been transferred  and merged  and there is no reason why the principle ’Last-in, First-out’ should be invoked for drawing the inference  that the  payment has  been made  out of  the current year’s profits. He pointed out that such a principle was applied  by the  Bombay High  Court  in  two  decisions, namely, Commissioner  of Income-Tax, Bombay City-l v. Bharat Bijlee Ltd.(1)  and Commissioner of Income Tax, Bombay City- ll v. Marrior (India) Ltd.(2) but urged that there 821 was no warrant for it. In support of his contention that the entire A  General  Reserve  of  Rs.  86,07,712  without  any deduction  should   have  been   taken  into  account  while computing  the  capital  of  the  assessee-company,  counsel relied upon  a decision  of the Andhra Pradesh High Court in Super Spinning  Mills Ltd.  v. Commissioner  of Income  Tax, Hyderabad(l).      Alternatively counsel  pointed out that as far as stock valuation is  concerned a  question often arises whether the

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stock on  hand at the end of the year is to be valued at the closing price  or at  the  initial  purchase  price  and  in ’Advanced Accounting’ by R. Keith Yorston and E. Bryan Smyth (a treatise  on the principles and practice of accounting in Australia) three  methods of  valuing the closing stock have been indicated at pages 441 and 442 of Vol. II (5th Edn.) of the treatise,  namely, (a)  First-in First-out,  (b) Last-in First-out and  (c) Average  Cost. In  regard to  these three methods the authors have stated thus .      (a) First-in First-out           The assumption  underlying this method is that the      oldest stock  is used or issued first or that sales are      made in  the order  in which the goods are purchased or      produced.  If  there  are  several  lots  of  goods  at      different prices,  they are regarded as being exhausted      in the order of purchase. On a rising market this would      write off the lower-priced lots first, and on a falling      market the higher-priced lots would go first."      (b) "Last-in First-out.           This  method  assumes  that  the  items  of  stock      purchased are  the first  to be issued or sold and thus      the stock  remaining is  valued  at  the  cost  of  the      earlier purchase."      (c) Average Cost.           On this  basis issues  of stocks are valued at the      weighted average  cost of  the stock  on  hand  at  the      beginning and of the purchases, less any issues already      made." 822 Counsel for  the assessee urged that for determining whether the entire  General Reserve  of  Rs.  86,07,712  or  reduced General Reserve  of  Rs.  82,97,262  should  be  taken  into account for  capital computation either the ’First-in First- out’  principle   should  be   adopted;  if   not,  only   a proportionate deduction  should  be  made  and  the  balance should be  held to  be includible  in  capital  computation, particularly because the payment of dividend has been from a conglomerate fund.      It  is   not  possible   to  accept   either  of  these contentions urged by counsel for the assessee-company. It is true that under s. 205(1) a of the Companies Act, 1956 it is open to  the directors to recommend and the share-holders to approve payment  of dividends either from the current year’s profits or  from the  past year’s  profits. It  is also true that on  transfer of  a portion of current year’s profits to the General  Reserve the augmented General Reserve becomes a conglomerate fund but having regard to the natural course of human conduct of hard-headed men of business and commerce it is not  difficult to  predicate  that  the  dividends  would ordinarily be  paid out  from the current income rather than from the  past savings  unless the directors in their report expressly or  specifically state  that payment  of dividends would be  made from  the past  savings. From  the commercial point of  view if  any amount  is required for incurring any expenditure or  making any disbursement like distribution of dividends in  a current  year, then ordinarily the same will come out  of the  current income  of the  company if  it  is available and only if the same is insufficient then the past savings will  be resorted  to for  the purpose  of incurring that expenditure  or making that disbursement; such a course would be  in accord  with the common sense point of view. We may point  out that  this  aspect  of  the  matter  was  not considered  by  the  Andhra  Pradesh  High  Court  in  Super Spinning Mills  Ltd. case (supra) and the view of the Bombay High Court  in the  case of  Bharat Bijlee  Ltd. (supra) and

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Marrior (India)  Ltd. (supra) commends itself to us. Even in regard to  the question  of valuing  the closing  stock  the learned authors  of the  treatise referred to by the counsel for the  assessee-company merely  indicate three methods for such valuation  and it  will be open to a commercial concern to avail  of any  one method.  In our view in the context of the question  whether while  incurring  any  expenditure  or making any  disbursement a commercial concern will resort to current income  or past  savings, the  normal rule,  in  the absence of  express indication  to the contrary, would be to resort to the current income rather than past savings. 823      In our  view, therefore,  the  Tribunal  was  right  in excluding the  sum of Rs. 3,10,450 from the General Reserves while computing  the capital of the assessee-company for the assessment  year   ]974-75,  in   the  absence   of  express indication to the contrary.      In the  result Civil  Appeal No.  1614(NT) of  1978 and Review Petition  No. 57  of 1980 are dismissed. Civil Appeal No. 860  of g  1973 is  partly allowed and the issue whether the appropriation  for retirement  gratuity is  a reserve or not is  remanded to the Taxing Authority and the rest of the appeal is  dismissed. In Tax Reference Cases Nos. 2 and 3 of 1977 and  No. S  of 1978  the questions  referred to  us are answered  in  favour  of  the  Department  and  against  the assessee-companies. Each  party will  bear its  own costs in all the matters.      AMARENDRA NATH  SEN, J. At the outset I wish to observe that  I  have  been  somewhat  diffident  in  hearing  these matters. I  felt a  little embarrassed  as I found that as a Judge of  the High  Court at  Calcutta, I had an occasion to consider some  of the  questions in  the case of Braithwaite and Co.  (India) Ltd.  v. Commissioner of. Income- Tax, West Bengal, (I)  (Income Tax  Reference No.  262 of  1969). As I have already  considered some  of  the  questions  and  have expressed my  views on the same in the judgment delivered by me in  the said  reference, I was wondering whether I should hear  these  appeals.  The  members  of  the  Bar,  however, represented to  me that they had not only no objection to my hearing these  appeals but they also wanted me to hear these appeals. They further represented that most of the Judges of this Court  had on  some occasion  or other considered these questions. They  further stated  that if  I would decline to take up  these matters  not only  the members of the Bar who had come from various parts of the country for these appeals would be  seriously inconvenienced;  but also  the  litigant public who  had been  waiting for  years for  the hearing of these matters  would be  prejudiced. It  was further pointed out to  me that  the judgment  which was delivered by me was not under  appeal and  further  it  would  appear  from  the judgment  which  I  had  earlier  delivered  in  Braithwaite matter, there  was in  fact a concession made by the learned counsel appearing  on behalf  of the  assessee that the said case was covered by the decision of the Supreme Court in the case of  Commissioner of  Income-tax Bombay  City v. Century Spinning and  Manufacturing Co. Ltd. (’) The learned counsel appearing on behalf 824 of the  parties further  represented to  me that the earlier judgment was  delivered by  me as  a Judge of the High Court and it  was always  open to  me to  reconsider  ’  my  view, particularly as  a Judge  of this  Court after  hearing  the submissions to  be made  by the learned counsel appearing on behalf  of   the  parties.   In  view   of   the   aforesaid representations and submissions made by the learned lawyers,

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I was  persuaded to  hear  these  appeals  with  my  learned brothers to  avoid inconvenience not only to the lawyers but to the  litigant public. I have also had no doubt in my mind that if  I felt  after hearing  the submissions  made by the learned counsel  appearing on behalf of the parties in these appeals, that the earlier judgment delivered by me was wrong and incorrect,  I would  have no hesitation in reconsidering my earlier decision.      I do  not propose  to set out the facts of this case at any length  in this  judgment. The facts have been fully and correctly set  out in  the judgment  of my  learned  brother Tulzapurkar, J.  My learned brother in his judgment has also dealt with  the various  arguments which  were advanced from the Bar  and has  also considered  the decisions  which were cited.      I propose  to notice  only some of the decisions which, to my  mind, are  particularly important for decision of the question whether the provision made in the balance-sheet for payment of  dividend to the share-holders recommended by the Board of  Directors constituted  a ’reserve’ and the amount, so set apart, should be taken into account, in computing the capital of  the company for the purpose of Super-Profits Tax Act, 1963.  It may  be noted  that in  the  Act  itself  the expression ’reserve’ has not been defined.      In the  case of Commissioner of Income-tax, Bombay City v. Century Spinning and Manufacturing Co. Ltd. (supra), this Court had  the occasion  to consider the meaning of the word ’reserve’ while  dealing with  a case under Business Profits Tax Act  (XXI of 1947). In this Act also, there were similar provisions with  regard to computation of the capital of the Company  and  the  assessee  had  claimed  that  the  amount recommended by  the Board  of Directors  and  earmarked  for payment of  the dividend  to  the  share-holders  should  be treated as  ’reserve’ and should be taken into consideration in computing  the capital of the assessee. The Supreme Court observed at pp. 503-504 as follows :-           "The term  ’reserve’ is not defined in the Act and      we must  resort to  the  ordinary  natural  meaning  as      understood 825      in common  parlance. The dictionary meaning of the word      ’reserve’ is :-                "1 (a)  To keep  for future use or enjoyment;           to store  up for some time or occasion; to refrain           from using or for enjoying at once.                (b) To keep back or hold over to a later time           or place or for further treatment.                6. To set apart for some purpose or with some           end in view; to keep for some use.                II.  To   retain  or   preserve  for  certain           purposes (oxford Dictionary, Vol . VIII, P. 513.)                In  Webster’s  New  International  Dictionary           Second Edition,  page 2118 ’reserve’ is defined as           follows:                1. To  keep in  store for  future or  special           use; to  keep in  reserve; to  retain, to keep, as           for oneself.                2. To  keep back; to retain or hold over to a           future time or place.                3. To preserve."      The Supreme  Court further observed at p. 504: "What is the true  nature and  character of the disputed sum, must be determined, with  reference to the substance of the matter?" The Supreme Court held at p. 504-505 as follows :-           "A reserve  in the  sense in  which it  is used in

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    rule 2 can only mean profit earned by a company and not      distributed as  dividend to  the shareholders  but kept      back by  the directors  for any purpose to which it may      be put  in future.  Therefore, giving  to the ’reserve’      its plain  natural meaning  it is clear that the sum of      Rs. 5,08,637   was  kept in  reserve by the company and      not distributed  as profits  and subjected to taxation.      Therefore, it satisfied all the requirements of rule 2.      The Directors  had no  power to  distribute the  sum as      dividend. They could only recommend as indeed they did,      and it  was upto  the shareholders  of the  company  to      accept that recommendation in which case alone the 826      distribution could  take place.  The recommendation was      accepted and  the dividend was actually distributed. It      is, therefore,  not correct  to say that the amount was      kept back.  The nature  of the amount which was nothing      more than  the undistributed  profits of  the  Company,      remained unaltered.  Thus the  profits Lying unutilised      and not  specially set  apart for  any purpose  on  the      crucial date  did not  constitute reserves  within  the      meaning of Schedule II, rule 2(1)."      The Supreme Court also referred to S.l31 (a) and 132 of the Indian  Companies Act.  Referring to  these sections the Supreme Court observed at p. 505 as follows:           "Section 131  (a) enjoins  upon the  directors  to      attach to  every balance sheet a report with respect to      the state  of company’s  affairs and  the amount if any      which they  recommend to be paid by way of dividend and      the amount,  if any, which they propose to carry to the      reserve fund,  general reserve  or reserve account. The      latter section  refers to  the contents  of the balance      sheet which  is to  be drawn  up in  the Form marked in      Schedule III.  This Form  contains a  separate head  of      reserves. Regulation  99 of  the Ist Schedule. Table A,      lays down  ’that the directors may, before recommending      any dividend  set aside  out  of  the  profits  of  the      company such  sums as they think proper as a reserve or      reserves  which   shall,  at   the  discretion  of  the      directors, be  applicable for meeting contingencies, or      for equalising  dividends, or  for any other purpose to      which the  profits  of  the  company  may  be  properly      applied.. ’ The Regulation suggests that any sum out of      the profits  of the  company which  is to  be made  asa      reserve or  reserves  must  be  set  aside  before  the      directors recommend  any dividend.  In  this  case  the      directors while recommending dividend took no action to      set aside  any portion  of this  sum as  a  reserve  or      reserves. Indeed, they never applied their mind to this      aspect of the matter. The balance sheet drawn up by the      assessee  as   showing  the  profits  was  prepared  in      accordance with  the provisions of the Indian Companies      Act. These provisions also support the conclusion as to      what is the true nature of a reserve shown in a balance      sheet."      In the  case of  Commissioner of Income Tax v. Standard Vacuum oil  Co. (1)  this Court had occasion to consider the decision in 827 the case  of Commissioner  of Income-tax v. Century Spinning and A  Manufacturing Co. Ltd. (supra). Dealing with the said decision of this Court held at p. 697-98 as follows :-           "The Court  was dealing  in  this  case  with  the      accounts of  an Indian  Company, the  balance-sheet  of      which was  prepared according  to the provisions of the

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    Indian Companies  Act, 1913. Regulation 99 of the First      Schedule, Table  A, required  that reserves must be set      apart before the directors recommended any dividend but      out of  the profits  of the  company no  amount was set      apart towards reserves before the directors recommended      payment of  dividend to  the shareholders. The identity      of the  amount remaining  on hand  at the  foot of  the      profit and  loss account  was not  preserved. rt  is on      these facts  that the  court held  that  there  was  no      allocation of  the amount  to reserve and from the mere      fact that  it was carried forward in the account of the      next  year   and  ultimately   applied  in  payment  of      dividend, it  could not  be said to be specifically set      apart for  any purpose  at the relevant date, i. e. the      end of the year of account."      This Court  then proceeded  to hold  at  p.  697-98  as follows :-           "We are  in  this  case  dealing  with  a  foreign      company and  the system  of accounting  followed by the      company is  different in  important respects  from  the      system which  obtains  in  India.  Companies  in  India      maintain diverse  types of  reserves: such  as  capital      reserve, reserve  for redemption of debentures, reserve      for replacement  of plant  and machinery,  reserve  for      buying new  plant to  be added  to the  existing  ones,      reserve for bad and doubtful debts? reserve for payment      of dividend  and general reserve. Depreciation reserves      within the  limit prescribed  by the  Income-tax Act or      the Rules  thereunder is  the only  reserve which  is a      permissible allowance  in the  computation  of  taxable      profits.  In   its  ordinary   meaning  the  expression      ’reserve’ means  something specifically  kept apart for      future use or for a specific occasion."      In the case of Metal Box Company of India Ltd. v. Their Workmen, (1)  this Court while dealing with a case under the pay- 828 ment of  Bonus  Act,  1965  had  occasion  to  consider  the expression ’reserve’  and its meaning for the purpose of the said Act. This Court held at p. 67-68 as follows :-           " The  next question  is  whether  the  amount  so      provided is  a provision or a reserve. This distinction      between a  provision and  a reserve  is  in  commercial      accountancy fairly  well known. Provisions made against      anticipated  losses   and  contingencies   are  charges      against profits and therefore, to be taken into account      against gross  receipts in  the P  & L  account and the      balance-sheet.  On   the  other   hand   reserves   are      appropriations of  profits, the asset by which they are      represented being  retained in form part of the capital      employed in  the business. Provisions are usually shown      in the  balance-sheet by  way of  deductions  from  the      assets in  respect  of  which  they  are  made  whereas      general reserves and reserve funds are shown as part of      the proprietor’s  interest  (see  Spicer  and  Pegler’s      Book-keeping and  Accounts,  15th  Edn.  page  42).  An      amount set  aside out  of profits  and other surpluses,      not  designed   to  meet   a  liability,   contingency,      commitment or  diminution in  value of  assets known to      exist at the date of the balance-sheet is a reserve but      an amount  set aside out of profits and other surpluses      to provide  for any known liability of which the amount      cannot be  determined with  substantial accuracy  is  a      provision; (see  William  Pickles  Accountancy,  Second      Edn. p.  192; Part  III, clause  7, Schedule  VI to the

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    Companies  Act,   1958,  which  derives  provision  and      reserve." In  the   case  of  Commissioner  of  Income-tax  v.  Mysore Electrical Industries  Ltd.(1) the  facts  were  briefly  as follows:-      Out of  the profits  of the  company for the accounting period ending  March 31,  1963. the Directors of the company appropriated  the  following  amounts  towards  reserves  on August 8,  1963: (i) Rs. 2,56,000 as plant modernisation and rehabilitation  reserve:  (ii)  Rs.  89,557  as  development rebate reserve. The question was whether these amounts could be included in computing the capital of the respondent as on April 1,  1963 under  rule 1 of Schedule II to the Companies (Profits)  Sur-tax   Act,  1964.  for  the  purpose  of  the statutory deduction  for the  assessment year  1961-65,  The contention  of   the   department   was   that   since   the appropriations were  made on 8th August, 1963 they could not be treated  as components  of capital as on the first day of the previous year i.e. 1st April, 1963. Negativ- 829 ing the  contention of  the department, this Court held that the  determination  of  the  Directors  to  appropriate  the amounts of  the three  items of  reserve on 8th August, 1963 had to  be related to first April, 1963, viz., the beginning of the  accounts for  the new year, and had to be treated as effective from  that day  and the said three items had to be added to  the other  items for computation of the capital of the company as on first April, 1963 under rule 1 of Schedule II to  the Companies  (Profits) Sur-tax Act, 1964. It may be noted that  in this  case before the trial court a claim had been made  by  the  company  that  a  sum  of  Rs.  3,15,000 representing  dividend  reserve  was  to  be  considered  in computing  the   assessee’s  capital   for  the  purpose  of Companies (Profits) Sur-tax Act, 1964 and the High Court had rejected this  claim. As against the rejection of this claim by the  High Court,  no appeal  had been  preferred  by  the assessee to  the Supreme  Court.  The  Supreme  Court  while considering the  three items which came up for consideration before it  held, as  already noted, that the decision of the directors to appropriate the amounts to these three items of reserve on  8th August, 1963 had to be related to 1st April, 1963 and this Court observed at pp. 560-570 as follows:-           "It is well known that the accounts of the company      have to  be made  up for a year up to a particular day.      In this  case that  day was the 31st March, 1963. If it      was reasonably  practicable to  make up the accounts up      to the  31st March,  1963, and  present the same to the      directors of  the respondent  on April  1,  1963,  they      could have made up their minds on that day and declared      their intention  of appropriating  the said  and  other      sums to  reserves of different kinds. But the fact that      they could  not do  so for  the simple  reason that the      calculation and  collection of figures of all the items      of income  and expenditure  of the company for the year      ending March  31, 1962,  was bound  to take  some  time      cannot make  any difference to the nature or quality of      the  appropriation   of  the  profits  to  reserves  as      determined by  the directors  after the first of April,      1963.  Their  determination  to  appropriate  the  sums      mentioned to  the three separate classes of reserves on      the 8th  August, 1963,  must be  related to  the 1st of      April, 1963,  i.e., the  beginning of  the accounts for      the new year and must be treated as effective from that      day". 830

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    Relying on  the aforesaid decisions and also many other decisions  of  the  various  High  Courts  which  have  been considered by  my learned  brother Tulzapurkar,  J.  in  his judgment, the  learned counsel  for the  assessee has argued that the  word ’reserve’  which has  not been defined in the Act, has  to be  understood in  its ordinary meaning as laid down by  the Supreme  Court in  the case of Century Spinning Mills Ltd.  The further  argument is that the recommendation for dividend by the directors of the Company does not create any kind  of liability,  immediate or  future. It  is argued that the obligation to pay the dividend only arises when the shareholders at  the Annual  General Meeting  of the Company decided to  accept the  recommendation of  the Directors and pass  a  resolution  for  declaration  of  dividend.  It  is submitted that  it is  open to  the Directors to withdraw or modify the  recommendations made by them any time before the shareholders accept  the recommendations  and in  support of this contention  reference is  made to  the decision of this Court in  the case  of Keshoram  Industries and Cotton Mills Ltd. v.  Commissioner of  Wealth Tax (Central), Calcutta (I) and n reliance is placed on the following observations at p. 772 :-           "The directors  cannot  distribute  dividends  but      they can  only recommend  to the  general body  of  the      company the  quantum of  dividend  to  be  distributed.      Under section  217 of  the Indian  Companies Act, there      shall be  attached to every balance-sheet laid before a      company in  general meeting  a report  by its  board of      directors with  respect to,  inter alia, the amount. if      any, which it recommends to be paid by way of dividend.      Till the  company in  its general  body meeting accepts      the recommendations  and  declares  the  dividend,  the      report of  the directors  in  that  regard  is  only  a      recommendation which  may be  withdrawn or  modified as      the case  may be.  As on  the  valuation  date  nothing      further happened  than a  mere  recommendation  by  the      directors as to the amount that might be distributed as      dividend, it is not possible to hold that there was any      debt owed  by the  assessee to the share holders on the      valuation date." It is further argued that it is open to the share-holders to accept the  i recommendations  in its  entirety or to modify the same by 831 deciding to  declare dividend  at a  rate lower than the one recommended by  the directors.  It is,  therefore, contended that the  recommendation of  the directors  for  payment  of dividend does  not have  the effect  of creating any kind of liability and there is no debt owed by the company by virtue of the  said recommendations. It has been submitted that the decision of  this Court  in the  case of  Mysore  Electrical Industries Ltd.  (supra) is  of no  assistance and  the said decision does  not lay  down that  in the event of the share holders’ acceptance  of recommendation made by the directors for the distribution of dividend to the share-holders of the company, the liability for payment of the dividend will also relate back;  and the doctrine of relation-back applies only in respect  of items  which the  directors are  competent to decide for  themselves, in  view of  the process involved in the preparation of accounts of the company.      The main  argument advanced on behalf of the Revenue is that any  amount which  may be  set  apart  for  payment  of dividend r  recommended to  be paid  by the Directors cannot constitute ’reserve’ within the meaning of the Act.      The argument advanced on behalf of the assessee appears

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to be  sound; but  to my  mind the  said arguments  are  not sufficiently convincing  to lead the Court to the conclusion that  the   amount  set   apart  for   payment  of  dividend recommended  by   the  Board  of  Directors  can  constitute ’reserve’ within  the meaning  of the Act for the purpose of computation of the capital of the Company.      The word  ’reserve’ has not been defined in the ACT. In the absence  of any  such definition  the  word  has  to  be understood in  its ordinary  sense. It  is, however,  to  be remembered that  the word  ’reserve’  in  the  instant  case occurs in a taxing statute specially applicable to Companies only. The  word ’reserve’  should be so construed as to give the  said  word  the  meaning  in  which  it  is  ordinarily understood by  persons interested in Companies or in dealing with Companies.  In other  words, the word ’reserve’ for the purpose of  this Act  should be  understood in  the sense in which it  is understood  in company  circles and  by persons interested in  Companies and  in dealing  with Companies. It may be  noticed that  while considering the true meaning and true nature  of ’reserve’,  the Supreme Court in the case of Commissioner  of   Income  Tax   v.  Century   Spinning  and Manufacturing Co. Ltd. (supra) has referred 832 to S.  131 (a)  and 132  of the Indian Companies Act, to the Form marked  in Schedule  III in  which balance sheet of the Company has  to be prepared and also to Regulation 99 of the First Schedule,  Table A. I have earlier quoted the relevant observations of the Supreme Court.      It is,  no doubt, true that the re commendations of the Directors for  payment of  any dividend  does not create any kind of  liability for  the payment  of the said amount. The liability for  payment of any amount by way of dividend only arises when the share-holders accept the recommendations and a dividend  is declared at the annual general meeting of the Company. It  is open  to the Directors to modify or withdraw the recommendation  with regard  to the  payment of dividend before the  said recommendation  is accepted  by the  share- holders. It  is also open to the share-holders not to accept the recommendation  of the  Directors in its entirety and to modify the  same. The legal liability for the payment of any dividend only  arises after  the share-holders at the annual general meeting  have decided  to declare  a dividend on the basis of  the recommendations  of the  Directors or  on  the basis of  any modification  thereof. The  liability for  the payment of  dividend only arises after the dividend has been declared by  the share-holders at the annual general meeting and this  liability does  not relate  back to  3 any earlier date on  the basis  of the recommendations of the directors. as the  directors do  not enjoy any power of declaring the b dividend. The  amount that  may be  set apart for payment of any dividend on the basis of the recommendations made by the Directors, cannot  be considered  to be  an amount set apart for meeting a known or existing liability.      Though the amount which is set apart for payment of any dividend recommended  by the  Board of  Directors is  not an amount  set   apart  for   meeting  any  known  or  existing liability, yet  the said  amount  so  set  apart  cannot  be considered to  be a  ’reserve’ within the meaning of the Act for the  purpose  of  computation  of  the  capital  of  the Company.      S. 210 of the Companies Act, 1956 specifically provides that at  every annual general meeting of a Company the Board of Directors  of a  Company shall lay before the Company the balance sheet  of the  Company and also the Profits and Loss account. S. 211

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833 further provides that every balance sheet of a Company shall give a  A true  and fair view of the state of affairs of the Company as  at the  end of  the Financial  Year  and  shall, subject to the provisions of the section, be in the form set out in  Part I  of  Schedule  VI,  or  as  near  thereto  as circumstances admit or in such other form as may be approved by the  Central Government  either generally  or in a parti- cular case.  The preparation  of  a  balance  sheet  in  the prescribed form and laying the same before the share-holders at the  annual meeting  are statutory requirements which the Company has to observe.      Regulation 87 of Table A in Schedule I provides:           "(1)  The   Board  may,  before  recommending  any      dividend, set  aside out  of the profits of the Company      such sums  as it thinks proper as a reserve or reserves      which  shall,  at  the  discretion  of  the  Board,  be      applicable for  any purpose to which the profits of the      Company may  be properly  applied, including provisions      for meeting  contingencies or for equalising dividends;      and  pending   such  application,   may  at   the  like      discretion, either  be employed  in the business of the      company or  be invested in such investments (other than      shares of  the Company)  as the  Board may from time to      time, think fit.           (2) The  Board may  also carry forward any profits      which it  may think  prudent  not  to  divide.  without      setting them aside as a reserve". This Regulation  contemplates that  the Board  may set aside out of  the profits  of the  Company such sums, as it thinks proper, as  a  reserve  or  reserves  which  shall,  at  the discretion of  the Board,  be applicable  for any purpose to which the  profits of  the Company  may be  properly applied including the  provisions for  meeting contingencies  or for equalising the  dividends, before recommending any dividend. In other  words, the  sums out of the profits of the Company have to  be set  apart as  reserve before  any  dividend  is recommended by  the Board;  and the  recommendation  of  the Board for  payment of dividend comes only after the creation of reserve. The amount that may, therefore, be set apart for payment of  dividend recommended  by the  Board is an amount which is set apart 834 after the Board had created the reserve. The form of balance sheet referred  to in  S. 211  of the Companies Act, 1956 is appended in  Part I  of Schedule  VI of  the Statute. In the statutory form  there are  various heads  including heads of various kinds  of reserves  and also  of provisions.  In the balance sheet  of the  Company which  has  necessarily  been prepared in  accordance with  the provisions  of the statute and in  the form  prescribed, the  amount recommended by the Board for  payment of dividend has been shown under the head provisions and  not under  any head  of reserves.  It is, no doubt, true that the true nature and character of the sum so set apart must be determined with regard lo the substance of the matter.  The substance  of the matter clearly appears to be that  the amount  is set  apart for  payment of  dividend recommended by the Board to be paid to the share-holders and the said amount is never intended to constitute a reserve of the Company.  Indeed a  provision is made for payment of the said amount  to the  share-holders by way of dividend on the basis of the recommendation made by the Directors. Though in law the  recommendation made by the Directors for payment of dividend to  share-holders does not create any liability for the payment  of dividend  and liability only arises when the

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shareholders accept  the said  recommendation, and though in law it  may be  open to  the Board to modify or withdraw the recommendation with regard to the payment of dividend before the acceptance  by the share-holders and it may also be open to the  share-holders not  to accept the said recommendation in its  entirety and  to modify  the same, yet, for business purposes, when  the directors  make any  recommendation  for payment of dividend and set apart any amount for the payment of dividend so recommended, the directors intended to make a provision for  the payment  of dividend  recommended by them and not  to create  any reserve,  as the Directors very well know that the recommendation made by them with regard to the payment of  dividend is  not normally  up-set by  the share- holders and  it is  generally accepted by the share-holders, as a matter of course. Any amount set apart by the Directors for payment  of dividend to the share-holders recommended by them, is  understood by persons interested in company and in dealing with  companies to  mean a provision for the payment of dividend  to the  share-holders and  is not understood to constitute a  reserve. In  my opinion,  this true nature and character of  the sum  so set  apart are  reflected  in  the provisions of the Companies Act and more particularly in the manner of preparation of the balance-sheet of the Company. I am, therefore,  of the opinion that the amount set apart for the payment 835 of any  proposed dividend on the basis of the recommendation of A the Directors cannot constitute reserve for the purpose of computation  of the capital of the Company. The view that I have  taken, to  my mind, appears to be in accord with the view earlier  expressed by  this Court  in the  decisions to which I have already referred.      On the  other questions, I entirely agree with the view expressed by  my learned brother Tulzapurkar, J. and I agree with the order proposed by him.           C.A. No. 1614(NT)/78, Review Petition No. 57180 and Tax Reference Cases Nos 2&3/77 and 5/1978 dismissed. P.B.R.                       C.A. No. 860/73 partly allowed. 836