1. These six appeals have been filed by K.C.P. Ltd. of Vuyyuru against the common orders of the Commissioner (Appeals), Hyderabad, for the assessment years 1972-73 and 1975-76 to 1979-80.
2. The assessee is a company liable to surtax under the Companies (Profits) Surtax Act, 1964 ('the Surtax Act'). The first common point for the assessment years 1972-73, 1975-76, 1976-77 and 1977-78 relates to the jurisdiction of the ITO for redoing the assessments under Section 8 of the Act. This ground was, however, not pressed during the hearing and it is, accordingly, dismissed.
3. The next common ground for all the years relates to the question of manner of treatment to be accorded to Quarry Land Amortisation Reserve shown in the balance sheet in the same name at Rs. 21,700 for the assessment year 1972-73, Rs. 1,05,500 for the assessment year 1975-76, Rs. 1,29,500 for the remaining four years. The assessee's accounting year is the year ending on 30th June. The question for consideration is whether the said reserve styled as a reserve should be taken as a reserve and, therefore, form part of the capital base or should be taken as a provision, as contended by the ITO. Schedule II to the Surtax Act prescribes the mode of computation of capital base as including capital and reserve among other things. The ITO would, however, seek to exclude the same on the ground that the Explanation to Rule 1 of Schedule II provides an exemption. The said Explanation reads as under : For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the heading 'reserves and surplus' or of any item under the heading 'current liabilities and provisions' in the column relating to 'liabilities' in the 'form of balance sheet' given in Part I of Schedule VI of the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule.
According to this Explanation, reserves falling under item 5 or 6 or 7 of the Reserves and Surplus on the liabilities side of the Form of Balance Sheet given in Part I of Schedule VI to the Companies Act, cannot be treated as a reserve. Item 5 deals with surplus in profits and loss account, while item 6 deals with proposed additions to dividends. Items 5 and 6 do not apply and they have not been applied.
Item 7, dealing with 'sinking fund', has been sought to be applied by the ITO. Quarry being a wasting asset, the provision of a sinking fund is not an uncommon accountancy practice. The ITO, therefore, took the view that this reserve should be treated as sinking fund and it was for this reason that he excluded the same from the computation of capital.
The first appellate authority concurred with him on the ground that the assessee holds leases over a number of mines for extracting limestone for the manufacture of cement. Since it is a wasting asset, he was of the view that it was prudent on the part of the assessee to provide for future needs with a view to replace the loss. The description as a reserve cannot by itself help the assessee ; according to him, as it was meant as a provision. The assessee is in second appeal.
4. The learned counsel for the assessee referred us to a definition of 'sinking fund' in Pickle's Accountancy. He pointed out that this is the definition in any standard work. This definition requires that in order that something may be described as a sinking fund, it should be reckoned with reference to the amounts required to replace the asset at the end of its effective life. Further, mere provision in the accounts is not enough inasmuch as equal sum should be provided for investment so that the amount invested along with its accretion will be sufficient to replace the asset. In the assessee's case, it was an ad hoc allocation. Besides, there was no corresponding investment. Provision, it is pointed out, is intended to cover a liability, which has accrued.
He also referred to the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559, which has brought out the difference between reserve and provision. The guidelines provided in the said decision, it was claimed, also will support his case. The learned counsel argued that it was written back to the profits and loss account in 1982. The learned departmental representative, on the other hand, claimed that the assessee has provided for the same. It was clearly styled as Quarry Land Amortisation Reserve. Quarry is a wasting asset. It was exploited during the year. It is claimed now to be an ad hoc allocation. He claimed that there is no reason why it should be treated so. The directors should presume to have applied their mind and made a proper allocation and the shareholders have approved such allocation. He urged that the fact that it has been earmarked as Quarry Land Amortisation Reserve, makes it a sinking fund. The fact that it was written back subsequent to these years to the profit and loss account during 1982-83, could not, prima facie, make the provision into a reserve during the relevant years.
5. We have carefully considered the records as well as the arguments.
The Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra) pointed out that the meaning assigned to the words 'provision' and 'reserve' should be the same as under the Companies Act. In fact, where the explanation is sought to be assigned as in this case, it is amply clear that the meaning should be the same as under the Companies Act.
The true nature and character of the sum appropriated from the profits has to be ascertained before finding out whether any particular item can be treated as reserve or provision. The authorities are right in canvassing the view that the mere fact that it is described as a reserve, need not lead to a conclusion that it is one. However, a provision is meant for meeting a known liability. It can also be intended to meet 'depreciation or the diminution in the value of assets'. Hence, the assessee is entitled to create a provision in respect of its quarries, while exhausting the same inasmuch as it is a wasting asset. But that does not automatically mean that the amount appropriated in this scheme has to be treated as a provision in every case. The intention and purpose of the appropriation has to be reckoned from surrounding circumstances. In this case, the amount has been earmarked for a specific purpose. But that itself is not enough. There 6hould be both intention and conduct on the part of the directors to use that fund for the very purpose. In the assessee's case, it is claimed that the appropriation in this name was an ad hoc one. Such a claim is also patent from the facts because it was only Rs. 21,700 that was provided in 1972-73. The amount stood at Rs. 1,05,500 in the assessment year 1975-76 and at Rs. 1,29,000 in the assessment year 1976-77. There was no further provision for four more years though the exhaustion of the quarries continued. It was, subsequently, written back to the profit and loss account. Even if the subsequent conduct is ignored by us, the fact remains that there is no uniform or even any basis inferable for the allocation with reference to the accounts or any statements of the directors or any other objective or subjective criteria. It has been an ad hoc allocation. It is also needless to point out that there has been no material to suggest that it was a tied-up reserve in the sense that there was any obligation cast upon the directors either by themselves or by resolution of the shareholders to use the funds only for amortisation purposes. It is in this context that we must consider it as a reserve. In fact, it has been styled as a reserve in' the accounts year after year. The assessee being a public company and the accounts having been approved by the shareholders year after year, we cannot ordinarily consider what is described as a reserve to be a provision unless there are materials to warrant the inference that though it has been described as a reserve, it is only a provision. Apparently, it is for this reason that the authorities themselves wanted to treat the amount as a 'sinking fund'. If it is a sinking fund, it gets squarely hit by the Explanation. The definition of sinking fund in any standard book on accountancy expects that there should be a provision on the basis that the amount provided should be invested in assets so that the investment, along with the accretion thereof, would meet the cost of replacement (less the residual value of the original asset). There is always the fund with its counterpart as investment which are both equal. It is known as a sinking or a reserve fund only where there is a corresponding investment earmarked specifically for replacement of the asset for which the fund has been created. This is the definition given in Pickle's Accountancy, as extracted by the assessee for our benefit. Even as pointed out by the learned representative for the assessee, this is the description given in any standard work on Accountancy. Eric L. Kohler in his Dictionary for Accountants, 4th edn., defines 'sinking fund' as under : Cash or other assets and the interest or other income earned thereon, set apart for the retirement of a debt, the redemption of stock, or the protection of an investment in depreciable property ; sometimes paralleled by a sinking fund reserve. A sinking fund established for the purpose of extinguishing indebtedness or reacquiring capital stock may also be known as a redemption fund.
The emphasis, it may be seen, is on the cash or other assets and not so much as mere accounting exercise as in the assessee's case, where the profit and loss appropriation account is debited and the reserve account is credited. Nothing more is done by the assessee. In fact, it has been written back. It was possible only because it was a reserve.
Under these circumstances, we find that the amount represented by Quarry Land Amortisation Reserve is a reserve within the ordinary meaning of the word 'reserve' or the meaning assigned under the Companies Act and/or in the light of the guidelines provided by the Supreme Court in Vazir Sultan Tobacco Co. Ltd.'s case (supra). It is certainly not a sinking fund inasmuch as none of the attributes of a sinking fund are apparent in this item. In any view of the matter, the assessee is entitled to succeed on this ground. The ITO is directed to rework the assessee's liability by treating these amounts as part of the capital base.
6. The only remaining item relates to the question of treatment of development rebate reserve withdrawn after the statutory period of eight years. This dispute relates to the assessment years 1976-77 and 1977-78 only. The amounts in dispute are Rs. 1,01,37,630 and Rs. 1,38,37,630 for the assessment years 1976-77 and 1977-78, respectively.
The first appellate authority, in rejecting the assessee's claim, had followed the decision of this Tribunal in Surtax Appeal Nos. 4 and 5 (Hyd.) of 1979, dated 26-3-1980. We, however, understand that the Andhra Pradesh High Court has reversed the decision of this Tribunal in the assessee's own case in Reference Case No. 75 of 1978, dated 14-6-1984 and Reference Case No. 210 of 1982, dated 25-6-1984.
Respectfully following the said decisions, we hold that on the amounts standing as part of the development rebate reserve after expiry of 8-year period with which the requirement for reserve ends, the benefit of treatment as a reserve can no longer be denied. The ITO is directed to give effect to the view of the High Court for the earlier years after due verification, since the assessee succeeds on principle. The appeal on this point will also be treated as allowed.
7. In the result, the appeals are treated as allowed in the manner indicated in the preceding paragraphs.