Kania, J.
1. These are two references on a case stated under section 256(1) of the Income-tax Act, 1961, as applied to surtax by section 18 of the Companies (Profits) Surtax Act, 1964 (referred to hereinafter as 'the Surtax Act'). The assessment years with which we are concerned are the assessment years 1968-69 and 1969-70. The questions which have been referred to us for our opinion are as follows :
'(I) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the 'debenture redemption reserve' and 'gratuity reserves' were 'other reserves' under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and the same are to be taken into account in computing the capital of the assessee company for the assessment years 1968-69 and 1969-70 ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the increase in the assessee's liability to the tune of Rs. 11,71,504.90 on account of devaluation of the Indian rupee on June 6, 1966, should have been allowed while computing the capital for the purpose of determining 'statutory deduction' under the Companies (Profits) Surtax Act, 1964, for the assessment years 1968-69 and 1969-70 ?'
2. As far as question No.(1) is concerned, it is agreed between the counsel that in view of our decision in Income-tax Reference No. 139 of 1975 - CIT v. National Rayon Corporation Ltd. : [1986]160ITR716(Bom) - dated September 17, 1985 (the judgment having been delivered by Kania J.) this question must be answered as follows (p. 722) :
'It is directed that when the matter goes back to the Tribunal, the Tribunal will have to determine whether the appropriation of Rs. 17 lakhs towards gratuity reserve is in excess of the liability of the assessee on account of gratuity determined on an actuarial calculation, and if there is such an excess, only to the extent of that excess will the amount be deemed to be a reserve and includible in computing the capital of the assessee company under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and as far as the sum of Rs. 79 lakhs representing debenture redemption reserve is concerned, it will not be includible in computing the capital of the assessee for the aforesaid purpose.'
3. We, therefore, propose to set out the facts only in so far as they are relevant to the determination of question No. (2).
4. By an agreement dated July 20, 1962, entered into between the assessee and the Industrial Credit and Investment Corporation of India (hereinafter for the sake of brevity referred to as 'ICICI'), the assessee, for the purpose of increasing the capacity of its caustic soda plant, utilised 8,05,480.03 dollars from the International Bank of Reconstruction and Development, Washington, through the ICICI. This was a dollar loan. After the payment of instalments up to January 1, 1966, an amount of dollars 5,70,102.02 equivalent to Rs. 27,18,994.89 remained to be repaid by the assessee. In May, 1966, the assessee repaid a loan instalment of dollars 51,187. The balance due from the assessee before the devaluation of the Indian rupee on June 6, 1966, was dollars 5,18,915.03. According to the loan agreement between the assessee and the ICICI, the said loan was repayable in dollars. By virtue of the devaluation of the Indian rupee on June 6, 1966, the liability of the assessee in respect of the said dollar payment in terms of the Indian rupees increased by Rs. 11,71,504.90. In the assessment of the assessee in respect of surtax for the two assessment years, it was claimed by the assessee that as the borrowings made by the assessee increased in terms of rupees by Rs. 11,71,504.90, that amount should be included in computing the capital of the assessee company for the purpose of determining the statutory deduction available under the Surtax Act. This addition was claimed in view of the provisions of rule l(v) of the Second Schedule to the Surtax Act. The Surtax Officer as well as the Appellate Assistant Commissioner rejected the claim of the assessee. On second appeal preferred by the assessee to the Income-tax Appellate Tribunal, the Tribunal took the view that the aforesaid amount of Rs. 11,71,504.90 was liable to be included in the computation of the capital of the assessee for the aforesaid purpose. The only contention taken up by the Revenue before the Tribunal was that the increase in the liability of the assessee was a mere notional increase and, hence, the said amount was not liable to be added in the computation of the capital of the assessee. It is from this decision of the Tribunal that the case has been stated and the aforesaid question referred to us.
5. The Surtax Act provides for the imposition of a special tax called surtax on profits of certain companies. In the computation of the income of the company for the purposes of levy of surtax, a statutory deduction is allowed which is a percentage of the capital of the company computed in accordance with the provisions of the Second Schedule to the Surtax Act or an amount of Rs, 2,00,000, whichever is greater. The Second Schedule to the Surtax Act contains the Rules for computing the capital of a company for the purpose of surtax. We are concerned with clause (v) of rule 1. The opening portion of the said rule read with the said clause runs as follows :
'(1) Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of - ...
(v) any moneys borrowed by it from Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution which the Central Government may notify in this behalf in the Official Gazette or any banking institution (not being a financial institution notified as aforesaid) or any person in a country outside India :
Provided that such moneys are borrowed for the creation of a capital asset in India and the agreement under which such moneys are borrowed provides for the repayment thereof during a period of not less than seven years.'
6. There is an Explanation to this section which is not material for our purpose.
7. It is an undisputed position that as far as the dollar loan pursuant to the said agreement dated July 20, 1962, is concerned, it complied with the requirements for the amount borrowed under it being included in the capital computation of the assessee company. In fact, the capital of the assessee company has been computed on that footing in the earlier assessment years. The dispute is only in respect of additional liability of Rs. 11,71,504.90 which arises on account of devaluation.
8. It was submitted by Mr. Jetly, the learned counsel for the Revenue, that the aforesaid increase in the liability on account of devaluation was not liable to be included in computing the capital of the assessee for the purposes of determining the statutory deduction as aforesaid as the enhanced liability was only notional because the amount of loan in terms of the foreign currency remained unchanged and there was no fresh borrowing. It was next submitted by him that as a result of this additional liability of Rs. 11,71,504.90, no capital asset has been created by the assessee company and, hence, the conditions contained in the proviso set out earlier were not satisfied and the amount of increased liability cannot be included in the computation of capital of the assessee. In our view, it is not possible to accept either of these submissions. In the first place, it is the accepted position that the aforesaid dollar loan was borrowed by the assessee for the creation of a new capital asset. It must also be taken as the agreed position that the agreement in respect of the said dollar loan was one which complied with the terms of rule 1(v) and the proviso in the Second Schedule. We fail to see how it can be said that the increased liability of the assessee on account of devaluation was merely notional because, in fact, the assessee had to pay Rs. 11,71,504.90 more to discharge its liability for repayment of the loan and hence there was nothing notional about this increase in liability. As far as the creation of a capital asset from the amount of additional liability on account of the borrowing is concerned, we fail to see how that question arises. It is the accepted position that the dollar loan was utilised in the creation of a new capital asset and there seems to be nothing in the plain words of the proviso to the rule which would suggest that where the liability to repay the loan of a foreign currency goes up in terms of the Indian rupees on account of devaluation, any capital asset must be created from the amount representing that increased liability. In fact, requiring this would be against all common sense because it is not that any additional amount of decided dollars came into the hands of the assessee by reason of the devaluation of the Indian rupee. It is only the liability of the assessee which went up and the amount borrowed in dollars was utilised, in fact, for the creation of the capital asset. In this regard, it was submitted by Mr. Jetly, in the alternative, that in order that the increased liability can be included in the computation of the capital of the assessee, the assessee was required to show that the capital asset was created after the increase in liability. We fail to see how much a thing would be required in a case like this where the liability goes up on account of devaluation. However, there is nothing in the statement of the case to show that the capital asset, namely, the addition to the caustic soda plant, was completely constructed before June 6, 1966. This is natural, because this argument has been advanced for the first time before us on behalf of the Revenue and there was not even a faint trace of such an argument before the Tribunal.
9. Mr. Jetly placed reliance on the decision of a Division Bench of the Madras High Court in Kannapiran Mills Ltd. v. CIT : [1977]106ITR947(Mad) . In our opinion, the reliance placed by Mr. Jetly on this decision is entirely misplaced. In fact, in the case before the Madras High Court, there was no question of any increase in any liability on account of devaluation and the facts were altogether different. What Mr. Jetly wants to emphasise is that in this decision, the Madras High Court has held that to comply with the proviso to item No. (5) of paragraph 1 of the Second Schedule to the Surtax Act (which we have referred to as 'rule 1(v)'), the borrowing must be for the creation of a capital asset, that is, creation of the capital asset must be subsequent to the borrowing and if the creation of the capital asset precedes the borrowing, the borrowing cannot be considered to be for the purpose of creation of the capital asset. It would be interesting to remember that in that case, the borrowings in question had been made only partly for payment towards machinery supplied and the bulk of the amount borrowed was to be utilised for repayment of deposits taken from the public. As we have already pointed out, there is nothing on the facts of the case before us to show that the capital asset in question was created before the increase in the liability of the assessee on account of devalutation. Moreover, the principle laid down by the Madras High Court is in the context of altogether different facts. It can have no no application to a case of devaluation like the one before us.
10. In the result, question No. (2) is answered in the affirmative and in favour of the assessee.
11. The Commissioner to pay the costs of these references in one set.