Commissioner of Income-tax Vs. Vazir Sultan Tobacco Company Ltd. - Court Judgment

Excerpt:
direct taxation - depreciation - section 34 (3) and rule 1 of schedule to income tax act, 1961 - assessee set apart certain amount as reserve out of profit after meeting tax liability calling it depreciation reserve - question raised was whether such amount of depreciation reserve can be brought within expression of other reserve - depreciation reserve known as secret reserve and meant for being used for purpose of company in future - held, such reserve falls within expression of other reserve. - - in february 1946, the directors of the company recommended that out of the said amount, a sum of rs. it clearly supports the assessee's case and is in accord with our opinion, though it is true that the said decision was rendered before the supreme court pronounced its judgment in vazir sultan tobacco company ltd. though this decision dealt with the 'development rebate reserve' and placed strong reliance upon the circular issued by the board, it is clear that the reasoning employed therein accords with our conclusion. 15. learned standing counsel for the revenue placed strong reliance upon the decision of the allahabad high court in cit v. the bench was, therefore, of the view that the test enunciated by the supreme court in century spinning was not satisfied.b.p. jeevan reddy, j.1. the only question referred in this case relates to the computation of the capital base of the assessee-company under the companies (profits) surtax act, 1964. the question referred is : 'whether, on the facts and in the circumstances of the case, the income-tax appellate tribunal was justified in holding that the excess provision made for depreciation was a reserve forming part of the capital for the purpose of surta ?' 2. the assessee is vazir sultan tobacco company, a public limited company, engaged in manufacturing cigarettes and other tobacco products. 3. the second schedule to the act provides rules for computing the capital of a company for the purpose of surtax. rule 1, in so far as it is relevant, reads 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 - (i) its paid-up share capital; (ii) its reserves, if any, created under the proviso (b) to clause (vib) of sub-section (2) of section 10 of the indian income-tax act, 1922, (11 of 1922), or under sub-section (3) of section 34 of the income-tax act, 1961 (43 of 1961); (iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the indian income-tax act, 1922 (11 of 1922), or the income-tax act, 1961 (43 of 1961)...' 4. in this case, we are concerned with the assessment years 1969-1970 and 1970-71. the assessee has been adopting a procedure of providing depreciation in its accounts far in excess of the depreciation allowable under the income-tax act, which it was calling 'depreciation reserve'. this was with a view to provide for unforeseen contingencies. such reserves in commercial parlance, are known as 'secret reserves'. these reserves are created out of the profits of the company after deduction of tax and are meant for being used for purposes of the company in future. in the course of the assessment proceedings under the act, the assessee claimed that the said 'depreciation reserve'. i.e., the amount set apart as depreciation reserve over and above the amount allowable by way of depreciation under the income-tax act, is in the nature of a 'reserve' and should, therefore, form part of the capital base. the surtax officer, refused to accede to this submission. following the decision of the allahabad high court in cit v. hind lamps ltd. : [1973]90itr487(all) , and of the mysore high court in mysore electrical industries v. cit : [1971]80itr571(kar) , he negatived the claim. on appeal, the appellate assistant commissioner agreed with the surtax officer. on further appeal, however, the income-tax appellate tribunal upheld the assessee's contention, whereupon the revenue asked for and obtained this reference. 5. sri m. suryanarayana murthy, learned standing counsel for the revenue, assailed the correctness of the view taken by the appellate tribunal mainly on the basis of and adopting the reasoning contained in the decisions of the allahabad and mysore high courts referred to above. he also relied upon certain other decisions to which we shall make a reference in due course. 6. on the other hand, sri y. ratnakar, learned counsel for the assessee, supported the reasoning and the conclusion of the tribunal with reference to several decisions to which also we shall refer at the proper stage. 7. in short, the controversy is whether the amount set apart as 'depreciation reserve' (over and above the amount allowed by way of depreciation under the income-tax act) constitutes 'reserve', and if so, whether it can be brought within the expression 'other reserves' mentioned in clause (iii) of rule 1 in the second schedule to the ac 8. in cit v. century spinning and . , the supreme court considered the meaning of the expression 'reserves'. the question had arisen in connection with the computation of the capital of a company under the business profits tax act, the relevant provisions whereof are in pari materia with the provisions concerned herein. the assessee therein was following the calendar year as its previous year. for the calendar year 1945, after making provision for depreciation and taxation, the balance of rs. 5,08,637 was carried to the balance-sheet. this sum was not allowed in computing the profits of the assessee for purposes of income-tax. in february 1946, the directors of the company recommended that out of the said amount, a sum of rs. 4,92,426 should be distributed as dividend and the balance carried forward to the next year's account. this recommendation was accepted by the shareholders in their meeting on april 3, 1946, and the amount was distributed shortly thereafter. in computing the capital of the assessee-company as on april 1, 1946, the assessee claimed that the said sum of rs. 5,08,637 should also be treated, as 'reserve'. the high court agreed with the same; but, on appeal, the supreme court held that the said amount did not constitute 'reserve' for the simple reason that no one with authority had allocated the said sum as 'reserve' on the relevant date and that on the relevant date it remained merely as a mass of undistributed profits. it observed further that on the relevant date, i.e., on april 1, 1946, there was a recommendation by the directors, which shows that far from treating it as a 'reserve', they had decided to earmark it for distribution as dividend. indeed, the shareholders accepted the said recommendation and the amount was distributed shortly thereafter as dividend. on this reasoning, the supreme court held that the said amount could not be treated and did not constitute a 'reserve' for the purpose of computing the capital base. in that connection, the supreme court examined the meaning of 'reserve'. observing that the said term is not defined in the act, it referred to its ordinary natural meaning as understood in common parlance, with reference to dictionaries, and held that 'reserve' means an amount kept back for future use or enjoyment, either generally or for certain specific purpose. it held that before an amount can be treated as 'reserve', it must firstly be a reserve as commonly understood. 9. this question was again considered by the supreme court in two other cases, viz., first national city bank v. cit : [1961]42itr17(sc) and cit v. standard vacuum oil company ltd. : [1966]59itr685(sc) . applying the test evolved in century spinning's case , the court held that the allocations made in accordance with the u. s. laws constitute a 'reserve' for the purpose of computation of the capital base. it was observed in both the cases that the amount set apart as a reserve was required to be kept apart by statutory instructions for future use or for a specific occasion. 10. the meaning of the expression 'reserve' as also the expression 'provision' was considered at some length by the supreme court again in vazir sultan tobacco company ltd. v. cit : [1981]132itr559(sc) . it was held that the expression 'reserve' not defined in the act, has to be understood in its popular sense, i.e., in the sense or meaning which is attributed to it by men of business, trade and commerce, and by persons interested in or dealing with companies. accordingly, it was held that the meanings attached to the words 'reserve' and 'provision' in the companies act, 1956, dealing with the preparation of balance-sheet and the profit and loss account would govern their construction for the purpose of the companies (profits) surtax act. it was observed that the distinction between 'provision' and 'reserve' is that a provision is a charge against the profits to be taken into account against gross receipts in the profit and loss account, while a reserve is an appropriation of profits, asset or assets by which it is represented, being retained to form part of the capital employed in the business. it was also observed that merely because any retention or appropriation of a sum is not a provision, that is, it is not designated to meet depreciation, renewals or diminution in the value of the assets or any known liability, it does not necessarily amount to a reserve. the question whether the concerned amounts constitute 'reserves' or not has to be decided having regard to the true nature and character of the sums so appropriated, depending upon the surrounding circumstances, particularly the intention with which and the purpose for which such appropriations had been made. the said propositions were reaffirmed by the supreme court in the recent case in cit v. elgin mills ltd. : [1986]161itr733(sc) . 11. applying the said test, let us examine the facts of the case before us. in this case, the assessee has set apart certain amounts as a reserve, calling it 'depreciation reserve'. this amount is set apart from out of the profits of the company after meeting the tax liability. the amount so set apart is over and above the depreciation amount allowed under the provisions of the income-tax act. this amount is known in commercial parlance as 'secret reserve', and is meant for being used for purposes of the company in future, as and when the occasion arises. in this case, there is evidence to show that such reserves have been utilised in the past for replacing machinery. in our opinion, therefore, it constitutes 'reserve' and falls within the scope of the expression 'other reserves' in clause (iii) of rule 1 of the second schedule to the act. it is not the case of the revenue that though the said allocation constitutes a 'reserve', it is of the nature of item (5), item (6) or item (7) occurring under the heading 'reserves and surplus' in the 'form of balance-sheet' given in part i of schedule vi to the companies act, 1956, as contemplated by explanation to rule 1. the said explanation reads as follows : '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) of 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 to 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.' even apart from the fact that no such contention is urged, we are of the option that the reserve set apart is not in the nature of any of the items (5), (6) or (7) referred to in the said explanation. 12. the decision of the calcutta high court in cit v. indian leaf tobacco development company ltd. : [1981]132itr831(cal) , relied upon by learned counsel for the assessee, is nearest on facts to the case before us. it clearly supports the assessee's case and is in accord with our opinion, though it is true that the said decision was rendered before the supreme court pronounced its judgment in vazir sultan tobacco company ltd. v. cit : [1981]132itr559(sc) . the calcutta high court has referred to the earlier decisions of the supreme court, including the one in century spinning's case , and came to the conclusion that the amount debited to the books in excess of the depreciation allowed under the income-tax act claiming the same as a 'reserve' is liable to be included in the computation of the capital base under the super (profits) tax act, the provisions of which act are in pari materia with the provisions concerned herein. 13. the other case relied upon by learned counsel for the assessee is cit v. otis elevator company (india) ltd. : [1977]107itr241(bom) . in this case, the board of directors resolved, during the previous year, to appropriate of the out of the profits a sum of rs. 2,10,000 towards 'general reserve'. this was approved by the shareholders at their meeting held on march 31, 1964. the income-tax officer refused to treat the said amount as part of the capital base on the ground that the said allocation does not relate back to and, therefore, cannot be taken into account on the first day of the previous year. the bombay high court, following the decision of the supreme court in cit v. mysore electrical industries ltd. : [1971]80itr566(sc) , negatived the said contention and also held with reference to the cbdt circular dated january 11, 1971, that the 'excessive development rebate reserve' can be treated as a 'reserve' and included in the capital of the company. though this decision dealt with the 'development rebate reserve' and placed strong reliance upon the circular issued by the board, it is clear that the reasoning employed therein accords with our conclusion. 14. in nagammal mills ltd. v. cit : [1974]94itr387(mad) , the madras high court also took the view that excess provision for bonus and 'development rebate reserve' forms part of the allocation for specified purposes. it held further that inasmuch as these amounts have been utilised by the company for its business purposes, the said items should be treated as 'reserves'. in this case also, the reserves were created over and above the amount granted by way of deduction under the provisions of the act towards bonus and development rebate. 15. learned standing counsel for the revenue placed strong reliance upon the decision of the allahabad high court in cit v. hind lamps ltd. : [1973]90itr487(all) . while affirming the principle enunciated in century spinning , the bench was of the view that the fourth item concerned therein, which was described as 'depreciation reserve' (representing the excess of depreciation over income-tax allowed depreciation) did not constitute a 'reserve' inasmuch as there was no evidence to show that the amount was set apart for future use. the bench was, therefore, of the view that the test enunciated by the supreme court in century spinning was not satisfied. it is thus clear that this decision turned on the facts of the case, viz., that there was no evidence to show that this particular amount was set apart for future use, either generally or for a specific purpose. it is not possible to infer any principle from this decision inconsistent with the decision of the supreme court in century spinning's case . indeed, the bench of the allahabad high court expressly followed that principle and applied it to the facts of the case before it. 16. reference is also made to the third decision of the mysore high court reported at page 571 in [1971] 80 itr as an appendix to the decision of the supreme court arising therefrom. it would be evident from a perusal of the said decision that the main question considered therein was, whether an allocation made in the middle of the previous year can be said to relate to the first day of the previous year. 17. for the above reasons, we answer the question referred to us in the affirmative, i.e., in favour of the assessee and against the revenue. there shall be no order as to costs.