1. This appeal has been filed by the assessee, the Kerala Financial Corporation, Trivandrum, against the order passed by the CIT, Trivandrum under s. 263 of the IT Act, for the asst. yr. 1994-95.
2. The assessee, an undertaking of the Kerala Government was assessed for the asst. yr. 1994-95 on a total income of Rs. 1,04,38,220. In the assessment under s. 143(3) of the IT Act, the claim for deduction of Rs. 70,04,148 under s. 36(1)(viii) was allowed in respect of the special reserve created by the assessee as a Financial Corporation engaged in providing long-term finances. The CIT later, on perusal of the records, noticed that even though the assessee had created the reserve to the extent of Rs. 71,18,786 by debiting the P&L a/c, the amount was transferred immediately to the 'Provision for bad and doubtful debts account' and that there was no amount available in the special reserve account. The CIT was of the view that the assessee was not entitled to the deduction under s. 36(1)(viii) as the amount from the special reserve had been transferred to another account leaving no reserve as such. He then issued a notice under s. 263 to the assessee proposing revision of the assessment. Overruling the assessee's objections, the CIT passed the impugned order under s. 263 on 25th November, 1998 directing the AO to withdraw the deduction granted under s. 36(1)(viii). Aggrieved with the order of the CIT the assessee has filed this appeal before the Tribunal.
3. On behalf of the assessee Shri V. Devarajan, C.A., submitted before us that the CIT was not justified in directing he AO to revise the assessment by withdrawing the deduction under s. 36(1)(viii). The learned representative submitted that the assessee had created the reserve of Rs. 71,18,786 by debiting the P&L a/c as could be seen from p. 15 of the annual report and thereby fulfilled the condition under s.
36(1)(viii) and so the assessee was entitled to the deduction under that section. Drawing our attention to p. 17 of the report, Shri Devarajan stated that subsequently in accordance with the guidelines issued by the IDBI in their letter, dt. 28th March, 1994, the assessee found it necessary to create a provision for bad and doubtful debts to the extent of Rs. 6,70,55,830. The entire amount of Rs. 6,26,46,092 available in the special reserve account under s. 36(1)(viii) was transferred to the for bad and doubtful debt account in compliance with the guidelines of IDBI. It was the contention of the learned representative that by creating the reserve with the debiting in the P&L a/c, the purpose of augmenting the resources had been served and that the entire amount was still available in the balance sheet under a different head. Shri Devarajan added that transferring the amount from the special reserve account for meeting the requirement of the controlling Government agency was a legitimate use of augmented resources and that could not be interpreted as violation of the provisions of s. 36(1)(viii). It was his contention that so long as there was no specific prohibition against the transfer of the funds for legitimate use of the business, it would not be correct to insist on the reserve being retained intact. In this connection he drew our attention to the amendment brought about in s. 36(1)(viii) by the Finance Act, 1997. Shri Devarajan stated that only after the amendment there was the condition imposed that the reserve should be maintained as such and the violation would invite withdrawal of the benefit already granted. The learned representative submitted that the amended provisions would take effect from 1st April, 1998 only and so for the asst. yr. 1994-95 there was no such condition that the reserve should have been maintained throughout the previous year to entitle the assessee for the benefit of relief. Our attention was then drawn to the decision of the Supreme Court in the case of Shri Subhlaxmi Mills Ltd. vs. Addl. CIT (1989) 177 ITR 193 (SC), wherein it was held that creation of the reserve by book entries would be sufficient for the purpose of development rebate and the existence of profit during the year was not necessary. The learned representative also raised another contention that it was a case of invalid assumption of jurisdiction by the CIT on the basis of an objection by the audit party. According to the learned representative, the CIT had not exercised his discretion before issuing the notice under s. 263. He placed reliance on the decision of the Calcutta High Court in the case of Jeewanlal (1929) Ltd. vs. Addl. CIT (1977) 108 ITR 407 (Cal) for the contention that the CIT had to apply his mind before exercising the revisional jurisdiction under s. 263 and he should not have acted on the suggestion of the audit department. Arguing on the above lines, the learned representative urged us to cancel the order of the CIT and restore the assessment made under s. 143(3).
4. Per contra, the senior Departmental Representative, Shri Ambasanker Dev, supported the order of the CIT and submitted that when a concession was given to the assessee under s. 36(1)(viii) by way of deduction of an amount it was necessary that the provisions should be strictly complied with. In the present case, though the assessee had created the reserve by transferring Rs. 71,18,786 by debiting the profit and loss appropriation account immediately after the creation of the reserve, the entire amount had been transferred to the provision for bad and doubtful debts, leaving no balance in that account.
According to the learned senior Departmental Representative the intention of the legislature was defeated by the transfer of the amount to another account to satisfy another condition imposed by IDBI. He submitted that even though the amendment introduced in the Finance Bill, 1997 made the requirement of maintaining the reserve clearer and beyond doubt, earlier also the law required that the reserve should be available with the assessee. As regards the jurisdiction of the CIT the learned Departmental Representative stated that it could be seen from the revision order that there was clear application of mind by the CIT and that he had not been merely acting on the suggestion of anybody else. The CIT had gone through the records and verified the financial statements to find that the assessee had not kept the special reserve as such and that the entire amount had been transferred to the provision for bad and doubtful account. Shri Ambasanker Dev submitted that there was nothing to show that the CIT had acted on the suggestion of the Audit Wing without applying his mind and so that contention of the learned representative of the assessee was not correct.
5. We have given due consideration to the submissions on both sides and gone through the facts of the case. Sec. 36(1)(viii) permits deduction in respect of any special reserve created by a financial corporation which is engaged in providing long-term finance for industrial or agricultural development or development of infrastructure facility in India. It is not disputed that the assessee is such a corporation covered by s. 36(1)(viii). The deduction allowable is on an amount not exceeding forty per cent of the profit derived from the business of providing long-term finance, carried to the special reserve account.
The assessee claimed deduction under s. 36(1)(viii) on a sum of Rs. 70,04,148 in respect of a reserve of Rs. 71,18,786 created by debiting the profit and loss appropriation account for the year ended 31st March, 1994. In the assessment order for the asst. yr. 1994-95 the AO allowed the deduction. Later the CIT found that though there was the sum of Rs. 71,18,786 transferred of the special reserve as per s.
36(1)(viii), the entire amount in that account had been later transferred to another account, i.e., the provision for bad and doubtful account, leaving no balance in the special reserve account. On p. 17 of the annual report the details are shown as under : 7. The CIT found that the assessee had not in fact kept the special reserve as such and transferred the entire amount from the reserve account to the provision for bad and doubtful account in accordance with the guidelines issued by IDBI. As per the letter from IDBI, dt.
28th March, 1994, the assessee had to make provision for bad and doubtful debts to the extent of Rs. 6,70,55,830. It was found that the assessee had in the special reserve account under s. 36(1)(viii) a total sum of Rs. 6,26,46,092 including the sum of Rs. 71,18,786 transferred during the current year. On the view that it was necessary to comply with the directions of IDBI, the assessee found it necessary to create the provision for bad & doubtful debts and for that purpose the amount available in the special reserve account under s.
36(1)(viii) was utilised.
8. The question to be considered is whether by debiting the profit and loss appropriation account and by making a credit entry in the special reserve account, there would be sufficient compliance with the requirement of s. 36(1)(viii) even though the amount was immediately transferred from the reserve account to the provision for bad and doubtful debts account. Would it be sufficient compliance of the relevant provisions in s. 36(1)(viii) if the reserve is created by book entries without actually leaving any amount in the reserve account The learned representative, Shri Devarajan submits that by mere book entries the requirements of s. 36(1)(viii) are complied with and that there is no such condition that the special reserve should be maintained throughout the previous year. He submits that in the case of Shri Subhlaxmi Mills Ltd.'s (supra) the Supreme Court had approved the creation of the reserve by book entries for the purpose of development rebate even in the absence of profits in the business. There is the further contention that the need of maintaining the special reserve was introduced later by the Finance Act, 1997 and that for the asst. yr.
1994-95 there was no such requirement.
9. Is the creation of the special reserve under s. 36(1)(viii) an idle formality True, there is no stipulation that the special reserve should be maintained for a specified period. Does it mean that by mere creation of the reserve by debiting the profit & loss appropriation account, there would be sufficient compliance of s. 36(1)(viii) despite the immediate transfer of the entire amount from the special reserve account to an altogether different account In this context, we may refer to the decision of the Supreme Court in the case of Indian Overseas Bank Ltd. vs. CIT (1970) 77 ITR 512 (SC). In that case the Supreme Court was considering the provisions relating to creation of the reserve for the purpose of development rebate. In that case the bank had transferred a sum of Rs. 6 lakhs from the P&L a/c to the reserve fund. That sum was sufficient to meet the requirements of s. 17 of the Banking Companies Act, 1949 as well as the provisions relating to development rebate reserve. The contention of the assessee was that as the transfer to the reserve was sufficient to meet the requirements of s. 17 of the Banking Companies Act as well as the provisions relating to development rebate reserve, in substance, if not in form, it had complied with the requirement of law, and therefore, it was entitled to the allowance of development rebate claimed. In deciding the issue against the assessee the Supreme Court observed that the entries in the account books required by the provisions were not an idle formality. The Court further observed : "The reserve contemplated by that provision is a separate reserve.
The amount transferred to that reserve cannot be utilised for business purposes. The reserve contemplated by proviso (b) to s.
10(2)(vib) of the Act is an independent reserve. The amount to be transferred to that reserve is debited before the P&L a/c is made up. That amount is required to be credited to a reserve account to be utilised by the assessee during a period of ten years for the purpose of the business of the undertaking. The nature of the two reserves are different. They are intended to serve two different purposes. As observed by the Madras High Court in CIT vs. Veeraswami Nainar (1965) 55 ITR 35 (Mad) the object of the legislature in allowing a development of the assessee's business from out of the reserve fund is apparent from the terms of the proviso. The entries in the account books required by the proviso are not an idle formality. The assessee being obliged to credit the reserve fund for a specific purpose, he cannot draw upon the same for the purposes other than those of the business and the amount cannot be distributed by way of dividend." 10. The observation of the apex Court that the assessee is obliged to credit the reserve found for a specific purpose and so he cannot draw upon the same for some other purpose is significant in settling the dispute in the present case.
11. It is not clear from the records as to how long the assessee had kept the special reserve required under s. 36(1)(viii). As the transfer to the reserve has been effected from the profit & loss appropriation account vide p. 15 of the annual statement of accounts it can be seen that the reserve was created only after closing the accounts for the period ending on 31st March 1994. That means the entries where made as on 31st March, 1994. But before that the assessee received the guidelines from IDBI insisting on the creation of the provision for bad and doubtful debts. The entry relating to the creation of bad and doubtful debts must also have been made as on 31st March, 1994. That means as on 31st March, 1994, the assessee made the appropriation of Rs. 71,18,786 from the P&L a/c to the special reserve account under s.
36(1)(viii) and on the same day the entire amount in that account was transferred to the provision for bad and doubtful debts account. All these entries must have been effected on the same day with the result that on the same day when the special reserve had been created, there was no balance left behind in that account. Is it sufficient compliance with the provisions of s. 36(1)(viii) We do not think so, particularly in view of the decision of the apex Court that these are not an idle formality. The decision of the apex Court that these are not an idle formality. The decision in the case of Shri Subhlaxmi Mills Ltd.'s (supra) relied on by the learned representative only goes to show that mere book entries creating the reserve before drawing upon the P&L a/c would be sufficient compliance of the requirements regarding the creation of the development related reserve. But that claim does not lend support to the contention that after creating the reserve by book entries, the assessee would be free to transfer the amount to another account and still the reserve could be deemed to remain intact. In the case of CIT vs. Standard Motor Products of India Ltd. (1962) 46 ITR 814 (Mad) Madras High Court had held that the provisions relating to relief under s. 15C of the IT Act should be strictly construed. The same view was taken by the Kerala High Court in the case of Chembra Peak Estates Ltd. vs. CIT (1972) 85 ITR 401 (Ker).
We are not inclined to agree with the learned representative of the assessee that the transfer of the amount for the special reserve account was in compliance with the suggestion of IDBI and so it was utilisation of the funds for the business purposes of the assessee only and in that sense there was no violation of the provisions under s.
36(1)(viii). The important point to take note is that the money is not kept in the special reserve account.
12. The learned representative of the assessee has referred to the amendment in cl. (viii) of sub-s. (1) of s. 36 effected by Finance Act, 1997, w.e.f. 1st April, 1998. The amendment has the effect of substituting the words in cl. (viii) "in respect of any special reserve created", with the words "in respect of any special reserve created and maintained". The Memorandum explaining provisions of the Finance Bill, 1997 (vide 224 ITR St. 131) deals with the above amendment as under : "Maintenance of a special reserve by a financial corporation of a public company.
"Clause (viii) of sub-s. (1) of s. 36 permits the deduction of an amount not exceeding forty per cent of the profits derived from the business of providing long-term finance carried to any special reserve created by a financial corporation or a public company.
While this clause imposes a condition of creation of a special reserve, it does not impose any condition on the maintenance of the reserve.
In order to incorporate the condition regarding maintenance of the reserve, cl. (viii) is proposed to be amended by substituting the words 'special reserve created' with the words 'special reserve created and maintained'. An amendment to s. 41 is also proposed in order to bring to tax any amount withdrawn from such special reserve in the year in which the amount is withdrawn. For this purpose, a new sub-s. (4A) is sought to be introduced in this section and a reference of this sub-section is also sought to be made in sub-s.
(5).
The proposed amendments will take effect from 1st April, 1998, and will, accordingly, apply in relation to asst. yr. 1998-99 and subsequent years." 13. It can be seen from the above that the amendment has the effect of withdrawing the deduction already allowed under s. 36(1)(viii) in a subsequent year in which the amount is withdrawn from the special reserve account. In other words the amendment is not concerned with a case in which the withdrawal from the reserve is made in the same previous year in which the reserve is created. The amendment in cl.
(viii) should be read along with the amendment in s. 41, with the introduction of sub-s. (4A). If the amount is withdrawn from the special reserve in the same year, there would be no question of applying s. 41(4A) to withdraw the deduction already allowed. The amendment makes it all the more clear that at least as on the last day of the previous year the special reserve account should remain in tact to make the assessee eligible for the deduction under s. 36(1)(viii).
14. We do not also accept the contention that in this case the CIT had not applied his mind and that he had merely acted on the suggestion of the Audit Wing in holding that the assessee had not strictly complied with the requirement of s. 36(1)(viii). The learned representative of the assessee has not furnished any evidence before us to show that the CIT was acting on any suggestion of the Audit Wing without applying his mind. On the other hand, the reasons given in para 1 of the impugned order leave no room for doubt that the CIT applied his mind in coming to the finding that the order passed by the AO was erroneous and prejudicial to the interests of Revenue. The relevant portion of the order reads as under : "A perusal of the records for the relevant assessment year shows that even though the assessee had created the reserve to the extent of Rs. 71,18,786 by debiting the P&L a/c and crediting the special reserve account, it was transferred immediately debiting the special reserve account under s. 36(1)(viii) and transferring the entire balance in that account to provision for bad and doubtful debts account. In other words, the specific reserve under s. 36(1)(viii) did not exist during the relevant previous year and, therefore, the assessee was not entitled to the deduction under s. 36(1)(viii)." 15. From the above it can be seen that it was on perusal of the records for the asst. yr. 1994-95 that the CIT found that the special reserve under s. 36(1)(viii) did not exist during the relevant previous year as it had been transferred to the provision for bad and doubtful debts account. The contention that the CIT had acted on the suggestion of the Audit Wing and so the impugned order requires to be quashed cannot, therefore, be accepted. The case law relied on by the learned representative of the assessee - Sirpur Paper Mill Ltd. vs. CWT (1970) 77 ITR 6 (SC) and Jeewanlal (1929) Ltd.'s case (supra) are distinguishable on facts.
16. In the circumstances discussed above, we find no reason to interfere with the order of the CIT.17. We accordingly uphold the same and dismiss this appeal by the assessee.