Bharucha, J.
1. These are references at the instance of the Revenue under section 256(1) of the Income-tax Act, 1961, read with section 18 of the Companies (Profits) Surtax Act, 1964. The common questions posed therein read thus :
'(1) Whether, on the facts and in the circumstances of the case, the deferred taxation reserve of Rs. 75,000 as on January 1, 1965, January 1, 1966, and January 1, 1967, constituted 'reserves' as contemplated under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?
(2) Whether, on the facts and in the circumstances of the case, the doubtful debts reserve of Rs. 45,000 as on January 1, 1965, January 1, 1966, and January 1, 1967, Rs. 70,000 as on January 1, 1968, and Rs. 4,007 as on January 1, 1969, constituted 'reserves' as contemplated under rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?'
2. Under section 4 of the Companies (Profits) Surtax Act, 1964, surtax was charged on every company for every assessment year commencing on and from April 1, 1964, in respect of so much of its profits as exceeded the statutory deduction at the rates specified in the Third Schedule to the said Act. Statutory deduction was defined by section 2(8) of the said Act to mean an amount equal to 10 per cent. of the capital of the company computed in accordance with the provisions of the Second Schedule, or an amount of two hundred thousand rupees, whichever was greater. The questions before us are whether, for the purposes of computation of the capital of the assessee for the relevant assessment year in terms of the Second Schedule, its deferred taxation reserve and doubtful debts reserve were reserves and hence includible.
3. The balance-sheets of the assessee disclose the following :
----------------------------------------------------------------------'Assessment year Balance-sheet Deferred Doubtful debtsas at taxation reserve reserve----------------------------------------------------------------------Rs. Rs.1966-67 31-12-64/ 75,000 45,0001-1-651967-68 31-12-65/ 75,000 45,0001-1-661968-69 31-12-66/ 75,000 45,0001-1-671969-70 31-12-67/ - 70,0001-1-681970-71 31-12-68/ - 4,007'1-1-69----------------------------------------------------------------------
4. The statement of the case notes that the doubtful debts reserve of Rs. 45,000 had been brought forward from the year prior to December 31, 1964. To this amount, Rs. 25,000 was added in the year ended December 31, 1967. From this amount, bad debts of the value of Rs. 65,993 were written off in the year ended December 31, 1968. The Income-tax Officer declined to include the deferred taxation reserve in the computation of capital on the ground that it was not a free reserve. The Appellate Assistant Commissioner in appeal did not agree. The Tribunal found that e doubtful debts reserve was not designed to meet any existing liability the date of each of the balance-sheets but was designed to meet future contingencies. It held that it was, therefore, a reserve and includible the computation of the assessee's capital.
5. The position in regard to reserves for the purposes of computation of capital has been considered by the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT : [1981]132ITR559(SC) . This Bench has dealt with this judgment in detail in CIT v. Hindustan Lever Ltd. : [1986]160ITR700(Bom) (Income-tax Reference No. 51 of 1975 - decided on 2-9-1985). For the moment, it is enough to say that it was held that an amount set aside out of profits and other surplus not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet was a reserve; a provision was that which was made to meet a known or existing liability. Mr. Jetly drew our attention to the passage in the judgment (at p. 574) dealing with gratuity reserve. A scheme had been framed by the company before the Supreme Court by reason whereof there was a liability to pay gratuity to employees on the determination of their employment. The determination of employment was an event certain to happen. In the circumstances, the Supreme Court held that if a scientific method had been adopted to make an appropriation for gratuity representing fairly accurately a known and existing liability for the year in question, that was a provision. On the other hand, if an ad hoc sum was appropriated without resorting to any scientific basis, that appropriation was, to the extent it was in excess of the estimated liability, a reserve. These observations made by the Supreme Court in the context of gratuity reserve have no application to the case of a doubtful debts reserve.
6. This court in Goodlass Nerolac Paints Ltd. v. CIT : [1984]150ITR484(Bom) , considered the question of a reserve for doubtful debts in the light of the judgment in Vazir Sultan Tobacco Company's case : [1981]132ITR559(SC) . In the Goodlass Nerolac Paints Ltd.'s case : [1984]150ITR484(Bom) , the quantum of amounts which had been transferred to the reserve for doubtful debts had been determined ad hoc and without reference to any specific anticipated liability. The reserve had not been utilised for the adjustment of bad debts. It had been carried forward from year to year. In the circumstances, the fund constituting the reserve did not appear to this court to be in the nature of a provision but partook more of the character of a reserve.
7. In the instant case, an amount of Rs. 45,000 was brought forward from the previous year corresponding to the assessment year 1965-66. It was carried forward in the previous years corresponding to the assessment years 1966-67, 1967-68 and 1968-69. In the previous year corresponding to the assessment year 1969-70, an additional sum of Rs. 25,000 was brought in. It was only in the previous year corresponding to the assessment year 1970-71 that the amount of the reserve dropped to Rs. 4,007 and, in the statement of the case, it is stated that in the year ended December 31, 1968, bad debts in the sum of Rs. 65,993 had been written off. On these facts, it does not appear that the appropriation to the doubtful debts reserve was made to meet a known or existing liability or contingency. The doubtful debts reserve, accordingly, was in the nature of a reserve and not a provision and was, therefore, includible in the computation of the assessee's capital.
8. The appropriation to the deferred taxation reserve also appears to have been made ad hoc and without any specific, known or existing liability in mind. The Tribunal was, therefore, right in holding that the deferred taxation reserve was includible in the computation of the assessee's capital.
9. Accordingly, both questions are answered in the affirmative and in favour of the assessee.
10. The Revenue shall pay to the assessee the costs of the references in one set.