1. This appeal by the assessee is directed against the order in revision passed by the CIT, Coimbatore, on 30-11-1987.
2. In this case the sur-tax assessment for the assessment year 1979-80 was made on 12-6-1985. Subsequently, invoking the powers vested in him by and under Section 16 of the Companies (Profits) Sur-tax Act, 1964, the CIT called for and examined the records of the assessee. On such an examination, he found that the capital base had been wrongly determined by the Assessing Officer. According to the CIT, the error arose this way: In its accounts relating to the accounting year ending on 31-3-1978, the assessee had made a provision for taxation in a sum of Rs. 1,08,00,000. The Assessing Officer had computed the capital base, inter alia, on the basis of the said figure. The actual tax liability of the assessee, however, came to Rs. 1,16,40,276. Had the latter figure been taken into reckoning, the capital base of the assessee would have shrunk by a sum of Rs. 8,40,276 (Rs. 1,16,40,276-Rs. 1,08,00,000) and the sur-tax payable by the assessee would have gone up pro tanto. The CIT, therefore, concluded that the impugned sur-tax assessment was erroneous in that it was prejudicial to the interests of the revenue. He accordingly put the assessee on notice of his intention to pass suitable order in revision and invited the assessee to state its objections. The assessee responded by pointing out that the provision for taxation had been made on a reasonable basis and that, therefore, there was no justification for holding that the capital base had been wrongly computed by the Assessing Officer. The aforesaid argument did not find favour with the CIT, who passed the impugned order under Section 16 of the Act, directing the Assessing Officer to reduce the capital base by Rs. 8,40,276.
4. Shri T.S. Srinivasan, the learned counsel for the assessee took us through the facts and circumstances of the case. He invited our particular attention to the provisions of Rule 1A of the Second Schedule to the Companies (Profits) Sur-tax Act, 1964 and contended that the focus of the said Rule is on whether the provision for taxation actually made by the assessee was reasonable or not. Arguing that the provision for taxation actually made had been computed on a reasonable basis, Shri T.S. Srinivasan drew our attention to the further significant fact that while the tax payable on the income returned by the assessee came to Rs. 109 lakhs, the provision for taxation was made in the sum of Rs. 108 lakhs. This marginal difference itself would show that the provision for taxation actually made by the assessee was made on a reasonable basis. He, therefore, urged that the assessee is entitled to succeed.
5. Shri K.L. Tilakchand, the learned departmental representative, strongly supported the impugned order of the CIT (Appeals).
6. On hearing the rival submissions, we consider that the assessee is entitled to succeed.
7. The Income-tax Act imposes a charge on the total income of the assessee. On its part, the Companies (Profits) Sur-tax Act, 1964, levies an additional tax on the total income of a company in the manner stipulated by the Act. Sur-tax is levied basically on the excess of the chargeable profits over the statutory deduction. The First Schedule to the Act contains the Rules for computing the chargeable profits.
Briefly stated, chargeable profits are computed by taking as a starting point the total income computed under the IT Act, and by adjusting it in the manner stipulated in the Schedule.
8. The Second Schedule contains Rules for computing the capital base of the company. Broadly stated, under the said Schedule, the capital base is more or less equal to what in corporate accounting phraseology is known as "shareholders' funds". The capital base takes within its fold besides the paid up share capital, reserves (both free and tied) properly so called. It will at once be clear that the size of the capital base is a function of factors such as the size of the paid up share capital and the size of the reserves. Once the capital base is computed, the determination of the statutory deduction is merely an arithmetical exercise because, by definition (see Section 2(8) of the Act), statutory deduction means an amount equal to 15% of the capital base.
9. One thing will be clear from the foregoing and that is that if the capital base is increased - inflated, if you like - the statutory deduction will get increased or inflated pro tanto, and the sur-tax levied will in the process get reduced. The paid up share capital of the company, which is one of the components of the capital base being fixed, does not afford any scope for manoeuvring. Reserves, on the contrary, afford large scope for manoeuvring for more than one reason.
Firstly, the Companies (Profits) Surtax Act does not contain any definition of the term "Reserve". Secondly even the Companies Act, 1956 contains a negative definition of the said term. Thirdly, there is the anxiety of the tax-payer to enlarge the capital base by bringing under its pale as many items as possible under the heading "Reserves".
Fourthly, the question whether a particular sum set apart by the company is a 'provision' or a 'reserve' was a bone of contention till the Supreme Court handed down its decision in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981] 132 ITR 559.
10. Particularly, as respects provision for taxation and provision for proposed dividends, the legislative intent was that they are provisions simpliciter, and not a reserve and that consequently they should not be taken into reckoning for purposes of computing the capital base. It was, however, noticed that some of the companies were not showing provision for taxation or provision for proposed dividends in the balance-sheet; but were taking the sums required on both the counts to 'general reserves', thereby inflating the capital base for purposes of sur-tax. In order to curb this mischief, the Finance Act, 1976 inserted Rule 1A under the Second Schedule, with retrospective effect from 1-4-1975. The Rule brings the axe down in all cases where no provision is made in the balance-sheet either towards taxation or towards proposed dividends and reduces the reserve by the amounts which ought to have been provided for in the appropriation accounts towards taxation and dividends. It also applies to cases where there is a shortfall in the provision made for taxation and/or proposed dividends.
11. In its application to the latter type of cases (that is to say, in cases where there has been a shortfall in the provision made for taxation and/or proposed dividends), the Rule brings in the concept of reasonableness. With the result, Rule 1A is not meant to be applied automatically in all cases where there has been a shortfall in the provision made towards taxation and/or proposed dividends. Where the provision made is reasonable, even if there be some shortfall, such shortfall should be ignored.
12. In the case before us, we are concerned with the question whether the provision of Rs. 108 lakhs made for taxation was made on a reasonable basis. It is elementary that provision for taxation is made on the basis of book profits. For a fact, given the book profits, quantification of the provision to be made towards taxation is a simple arithmetical exercise. Even so, there may be cases where the book profits themselves had not been arrived at on the basis of well accepted accounting principles. For example, a company might claim depreciation on land; or again it may charge to revenue account an expenditure which is clearly capital in nature. It is in such cases that the test of reasonableness is to be applied and it must be held that deflating of book profits by such devices and the resultant shortfall in the provision for taxation is squarely hit by the provisions of Rule 1 A.13. Again, there may be cases where a particular item of expenditure or outgo might have been charged to revenue account, and the question whether such expenditure/ outgo is revenue deductible is itself a controversial issue. For example, Section 40(a)(ii) of the IT Act stipulates that, notwithstanding anything to the contrary in Sections 30 to 38, any sum paid on account of any rate or tax levied on the profits or gains of any business or profession or assessed at a proportion of, or otherwise on the basis of, any such profits or gains, shall not be deducted in computing the income chargeable under the head "profits or gains of business or profession". Now, in a particular case the question might arise whether the rate or tax levied was "levied on the profits or gains of any business or profession". Clearly, this is a controversial question. The question whether the wealth-tax payable by a company on its business assets is revenue deductible or not, is a typical case in point. Initially, in the case of Travancore Titanium Product Ltd. v. CIT [1966] 60 ITR 277 the Supreme Court held that such tax was payable by an assessee in its capacity as the owner of the assets and not in its capacity as a trader. Subsequently, however, in the case of Indian Aluminium Co. Ltd. v. CIT [1972] 84 ITR 735 the Supreme Court ruled that the wealth-tax payable by a company in respect of its business assets will be an allowable deduction. The line taken by the Supreme Court in the latter case was that, in so far as the tax pertains to business assets, the distinction that the company could not be said to be paying the tax in its capacity as a trader was not well founded. Immediately thereafter the President promulgated the Income-tax (Amendment) Ordinance, 1972, which was replaced later by the Income-tax (Amendment) Act, 1972, which inserted with retrospective effect from 1-4-1962 Sub-section (iia) into Section 40(a), the result of the retrospective amendment being to bring the legal position in conformity with the Supreme Court decision in the case of Travancore Titanium Products Ltd. (supra).
14. Now, if during the subsistence of such a controversy, the assessee-company were to take the line that the wealth-tax payable by it a revenue deductible and on that basis to charge the wealth-tax payable by it to its Profits and Loss Account, it could not be said that the company had acted in an unreasonable way, though in the process the book profits as well as the provision for taxation got reduced pro tanto.
15. The same considerations will also apply to additions made by the Assessing Officer in the course of the assessment proceedings, and which are subject matter of controversy.
16. We may now examine the issue before us in the light of the foregoing principles. In the case before us, the CIT has clearly proceeded on the basis that merely because the assessed tax was higher than the provision for taxation made in the books of the assessee, the capital base must be reduced pro tanto. For a fact, the impugned order in revision is based solely and exclusively on the difference of Rs. 8,40,276. The CIT has not brought on record any material to show how the provision itself was made at an unreasonably low figure. Indeed, the impugned order in revision does not contain any indication to the effect that the CIT had examined the matter from the point of view of the significant ingredient of Rule 1A, namely, reasonableness of the provision made.
17. In view of the foregoing, therefore, we hold that the CIT was not justified in taking recourse to the provisions of Section 16 of the Companies (Profits) Sur-tax Act, 1964. We, therefore, set aside the impugned order and restore that of the Assessing Officer.