Commissioner of Income-tax Vs. Modi Industries Ltd. - Court Judgment

B.N. Kirpal, J.

1. The Income-tax Appellate Tribunal has referred, under section 256(1) of the Income-tax Act, 1961, in relation to the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as 'the said Act'), the following question to this court :

'Whether, on the facts and in the circumstances of the case, the Income-tax Tribunal was right in holding that Rs. 40,50,000 appearing in the head 'Debenture redemption fund' could be included in the capital base ?'

2. The facts as found by the Tribunal are that, in respect of the assessment year 1971-72, the assessed-company, while computing the capital for purposes of surtax under the provisions of the Second Schedule to the said Act, included therein Rs. 40,50,000 appearing in the balance-sheet under the head 'Debenture redemption fund'. The Income-tax Officer was of the view that the said fund was a 'sinking fund' and that it had to be excluded in computing the quantum of reserve as per Explanationn to rule 1 of the Second Schedule to the said Act.

3. The assessed filed an appeal to the Appellate Assistant Commissioner. It was contended that the said fund was not a sinking fund because, corresponding to this amount, there was no earmarked investment. The Appellate Assistant Commissioner came to the conclusion that the said fund was in the nature of a provision because it was provided for meeting a known liability arising in future. He held that the assessed had to draw up its balance-sheet in accordance with the accepted principles and, for that purpose, the Companies Act, 1956, laid down a form of balance-sheet in Schedule VI. He further observed that certain notes were given in the said Schedule which defined various items. It was provided therein that the expression 'reserve' shall not include any amount written off or retained by way of providing for depreciation, renewals or diminution in the value of assets or retained by way of providing for any liability. He, accordingly, confirmed the order of the Income-tax Officer.

4. In the second appeal, it was contended on behalf on the assessed that the computation of capital in the year in question was done on the same basis as in the past, up to the year 1970-71, and it had never been disputed by the Department earlier. There were two sets of debentures of Rs. 50 lakhs each which had been issued. The first issue was to be paid by the company after January 1, 1972, but before January 1, 1976, while the second issue was to be redeemed after January 1, 1976, but before January 1, 1977. It was further contended that profits were appropriated and kept away from the reach of the shareholders with a view to create a reserve for redeeming these debentures. According to the assessed, there was no liability to be met by the company during this year and the fund set apart out of the profits could not be treated as a provision and the same was a reserve.

5. The Tribunal, after referring to various decisions of different High Courts, came to the conclusion that it had not been disputed before it that the funds represented by the debenture redemption fund were utilised in the business. There were created by appropriation of the profits through the profit and loss appropriation account. These funds were kept away from being distributed amongst the shareholders. There was no liability of the year which had to be met by these funds in this year. These funds had been set apart for use in the future. The Department conceded that these funds could not be regarded as sinking funds and, in view of the aforesaid, the Tribunal concluded that the said fund amounted to a reserve. It is thereafter that the aforesaid question of law has been referred to this court.

6. It has been contended by Shri Rajendra that the liability to redeem the debentures was known. He did not dispute that it was through the profit and loss appropriation account that the fund was created but he submitted that any amount set apart for a known liability could only be regarded as a provision. Our attention was drawn to the form of the balance-sheet and notes thereof appearing in Schedule VI to the Companies Act. The said form of balance-sheet requires figures to be given in respect of 'reserves and surplus' and also with regard to 'current liabilities and provisions'. In order to understand the said expression, viz., 'provisions' and 'reserves', Part III of the said Schedule VI defines the expressions 'provision' and 'reserve' and they are as follows :

'7. (1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires, -

(a) the expression 'provision' shall, subject to sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy;

(b) the expression 'reserve' shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability;

(c) the expression 'capital reserve' shall not include any amount regarded as free for distribution through the profit and loss account; and the expression 'revenue reserve' shall mean any reserve other than a capital reserve;

and in this sub-clause the expression 'liability' shall include all liabilities in respect of expenditure contracted for all disputed or contingent liabilities.

(2) Where -

(a) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or

(b) any amount retained by way of providing for any known liability;

is in excess of the amount which in the opinion of the directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this Schedule as a reserve and not as a provision.'

7. The said expression 'provision and reserve' came up for the detailed consideration before the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT : [1981]132ITR559(SC) . Interestingly enough, counsel for both the parties are relying on this decision in support of their respective contentions. It is this decision of the Supreme Court which has been referred to an followed in subsequent cases by the Supreme Court itself as well as different High Courts. We shall revert to them presently after examining the ratio of the decision in Vazir Sultan's case : [1981]132ITR559(SC) .

8. In Vazir Sultan's case : [1981]132ITR559(SC) , the Supreme Court was concerned with the question as to what was the difference between 'reserve' and 'provision' for the purposes of the Super Profits Tax Act, 1963, or the Companies (Profits) Surtax Act, 1964. The point in issue before the Supreme Court was whether the provision for taxation, provision for dividend and gratuity reserve should be regarded as a reserve or a provision. The court first referred to its earlier decision in Metal Box Co. of India Ltd. v. Their Workmen : (1969)ILLJ785SC , and quoted with approval the following passage from the said judgment (at page 591 of 132 ITR) :

'The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, thereforee, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respects of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest.'

9. The court then examined and considered the aforesaid clause 7 of part III of Schedule VI to the Companies Act and observed that the expression 'reserve' was negative in form and not exhaustive in the sense that it only specified certain amounts which were not to be included in the term 'reserve'. After examining the two provisions, it opined that, if any retention or appropriation of a sum falls within the definition of 'provision', then it could not be a 'reserve' but it did not follow that if the retention or appropriation is not a provision, then it automatically became a reserve. The substance of the matter had to be regarded and, in this context, the primary dictionary meaning of the term 'reserve' may have to be availed of. Whether a particular amount constitutes a reserve or not will have to be decided by having regard to the true nature and character of the sum so created and depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriation had been made. In deciding whether the appropriation was a reserve or not, the Supreme Court held in Metal Box's case (sic) : (1969)ILLJ785SC , that the following aspects provide some guidelines :

'(a) a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general reserve or a specific reserve :

(b) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised in future for a specific purpose and on a specific occasion; and

(c) a clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend in the same year would run counter to any intention of making that amount a reserve.'

10. On the facts of that case, the court came to the conclusion that provision for taxation was not a reserve but an excess over an amount which was reasonably necessary for meeting the liability would be a reserve. With regard to proposed dividend also, it was stated that the same was a provision and not a reserve. The conclusion of the court regarding gratuity reserve was that, to the extent it was based on actuarial valuation, it would be a provision and the excess would be a reserve. What is important to be noted is that what was regarded as a provision, and not as a reserve, was the liability of the company which existed as on the last date of the accounting year. It is for this reason that the actuarial valuation which was regarded as being relatable to the year in question was regarded as a provision. Furthermore, a reserve can be a general reserve or a specific reserve. An amount may be set apart for meeting a future liability from out of the company's profits and, if that liability is not in praesenti, then the said amount so set apart would be a reserve.

11. Shri Rajendra strongly relied upon three decisions of the Bombay High Court, delivered by the Bench, and contended that the debenture redemption fund had been created for the purpose of a known liability and, thereforee, it was a provision and not a reserve. Reference was first made to the case of CIT v. Hindustan Lever Ltd. : [1986]160ITR700(Bom) . In that case, the assessed-company claimed that the following items were includible in computing its capital for purposes of surtax. These items were (i) contingency reserve to meet possible demands for excise duty and sales tax, (ii) reserve for doubtful debts, (iii) super profits tax reserve, (iv) retirement gratuity reserve, and (v) dividend tax reserve. The Bombay High Court applied the decision of the Supreme Court in Vazir Sultan's case : [1981]132ITR559(SC) , and came to the conclusion that the contingency reserve consisted of amounts set apart to meet possible demands for excise duty and sales tax and as no assessment was ever made, no liability had ever accrued. These amounts were held to the includible in computing the capital. With regard to the super profits tax reserve, it was held that a correct computation should be made and only the excess amount would be regarded as a reserve. Similarly, with regard to the reserve for doubtful debts, it came to the conclusion that the said reserve had not been created on account of any possibility of debts becoming bad and, thereforee, had to be included in the computation of the capital. With regard to the tax on dividend, it was observed that as on January 1, 1964, there was no law in force imposing any tax on dividend but an amount, as dividend tax reserve, had been set apart which must relate back to January 1, 1964, and, if that liability had to be paid, then it would be a provision. Regarding retirement gratuity reserve, it was held that the Tribunal should determine as to what was the amount of the estimated liability on this account and if the amount set apart for gratuity reserve was in excess of such estimated liability, then the excess would have to be added in the computation of the capital. We do not find any observation in this judgment which can be of any assistance to the petitioner. The Bombay High Court in Hindustan Lever's case : [1986]160ITR700(Bom) , reiterated that it is a liability of that year which could not be taken into consideration while determining the capital.

12. A case on which strong reliance was placed was the second decision of the Bombay High Court in the case of CIT v. National Rayon Corporation Ltd. : [1986]160ITR716(Bom) . Here the question was whether the debenture redemption fund was a provision or a reserve. The Bombay High Court referred to the decision of the Supreme Court in Vazir Sultan's case : [1981]132ITR559(SC) and then held as follows (at page 721 of 160 ITR) :

'We may next come to the item of debenture redemption reserve. Although from the statement of the case, it would appear as if the figure of debenture redemption reserve was Rs. 79,00,000 in both the relevant previous year with which we are concerned, that does not appear to be really so. From the balance-sheets for the said periods, we find that in the calendar year 1965, the development rebate reserve was Rs. 79,00,000. However, in the next calendar year 1966, which is relevant to the assessment year 1967-68, the figure of debenture redemption reserve has gone up to Rs. 1,12,00,000. A perusal of the balance-sheet further shows that the assessed-company had floated and actually issued 6.5 per cent. secured redeemable mortgage debentures, as pointed out earlier, against the security of land, buildings and machinery of the company and a floating charge on the undertaking. None of these debentures appears to have been redeemed during the relevant previous years. There is no dispute regarding any of these facts. In these circumstances, it clearly appears to us that the debenture redemption. Since the aggregate amount of such debentures is much larger than the amount of the debenture redemption reserve, we fail to see how it can be said that there was any excess as such in this appropriation which could be taken as reserve. It is true that all the debentures had not become redeemable during the relevant previous years, but that does not make any difference because an amount set aside to meet a future liability, which was certain to come into existence, as in this case, must be regarded as a provision and not as a reserve.'

13. Two other decisions of the Bombay High Court, also dealing with debenture redemption found are again the cases of CIT v. National Rayon Corporation Ltd. : [1986]160ITR723(Bom) and CIT v. National Rayon Corporation Ltd. [1992] 193 ITR 577, where its earlier decision was followed.

14. Dr. Pal, learned counsel for the assessed, relied upon a decision of the Karnataka High Court in the case of Addl. CIT v. Bharat Fritz Werner (P.) Ltd. 0043/1978 : [1979]118ITR25(KAR) . In that case, an amount had been transferred from the profit and loss appropriation account to the preference shares capital redemption reserve account which was created under section 80 of the Companies Act to meet the liability to repay capital covered by redeemable preference shares. It was held by the High Court that the amount transferred to the preference share capital redemption reserve account was a reserve and not a provision. This conclusion was arrived at even though the Revenue had contended that since preference share capital had to be redeemed, it was a known liability and, thereforee, the amount set apart for that purpose was only a provision and not a reserve.

15. To the same effect is the decision of the Calcutta High Court in the case of CIT v. Placid Ltd. : [1984]150ITR74(Cal) . Following the ratio of the decision of the Supreme Court in Vazir Sultan's case : [1981]132ITR559(SC) , the court came to the conclusion that the capital redemption reserve was an amount earmarked or set apart to be utilised in future for a specific purpose or on a specific occasion, if necessary, and, as such, it fulfillls the tests of a reserve.

16. The decision of the Supreme Court in Vazir Sultan's case : [1981]132ITR559(SC) was again followed and applied by the same court in three (sic) decisions reported as CIT v. Laxmi Sugar and Oil Mills Ltd. : [1986]161ITR168(SC) , CIT v. Elgin Mills Ltd. : [1986]161ITR733(SC) and CIT v. Saran Engineering Co. Ltd. : [1986]161ITR741(SC) also. In Laxmi Sugar's case : [1986]161ITR168(SC) , the assessed had debited its profit and loss account for the assessment years 1961-63 and 1962-63 with sums of money as provision for additional cane price payable to cane growers under the price linked formula to be fixed by the competent authority under the Sugar Price Control Order, 1955. The items were shown under the head 'Current liabilities and provisions'. No payments were actually made and, in the accounting year, September, 1963, the assessed credited its profits by the said sum by reversing the entries. The question which arose was whether, for the purposes of the Super Profits Tax Act, 1963, in the assessment years 1961-62 and 1962-63, the said amount could be regarded as reserve. After referring to Vazir Sultan's case : [1981]132ITR559(SC) and Metal Box Co.'s case : (1969)ILLJ785SC , the Supreme Court held that the description in the balance-sheet was not conclusive of the true nature and character of the sum which is retained. Notwithstanding the fact that the said amount had been shown as current liabilities and provisions, the court in Laxmi Sugar's case : [1986]161ITR168(SC) , nevertheless held that (at page 171) :

'In the present case, when the evidence clearly discloses that there was no liability at all on the assessed requiring it to set apart a sum as a charge against its profits and there was never any intention to make payments to the cane growers nor was any payment ever made, but, on the contrary, the assessed reversed the entries in a subsequent year in its books, it is apparent that the amount cannot be described as a 'provision'. It can only be described as a 'reserve'. It was part of the capital which fell for computation under rule 1 of the Second Schedule.'

17. This conclusion was arrived at after the court reiterated that a 'reserve' was an appropriation of profits, the assets by which it is represented being retained to form part of the capital employed in the business, while a 'provision' is a 'present charge against the profits' and the assessed continues to enjoy a proprietor's interest in the reserve. The said principle of law is clearly applicable to the present case also because redemption of debentures was not a present charge on the profits of the company in the year in question.

18. In Elgin Mills' case : [1986]161ITR733(SC) , a question arose with regard to the inclusion of investment reserve, rehabilitation reserve, capital reserve, depreciation reserve and forfeited dividend reserve as a reserve or provision. The Supreme Court held, following the ratio of its earlier decision in Vazir Sultan's case : [1981]132ITR559(SC) and Metal Box's case : (1969)ILLJ785SC that the first four items constituted reserves. In arriving at this conclusion, it was observed that (at page 740) :

''Reserves' consist of appropriations from profits and other surpluses and retained for future use. This, however, does not include any amount which had been kept to meet any liability or diminution in the value of assets known to exist as on the date of the balance-sheet.'

19. What has been emphasised is that the liability must exist as on the date of the balance-sheet and should not be a liability which comes into existence in future. It is only the liability which exists in the year in question which can be a charge on the profits and thereby be regarded as a provision. In Saran Engineering's case : [1986]161ITR741(SC) , it was observed as follows :

'It may be mentioned that where the liability has actually arisen or is anticipated legitimately by the assessed though the quantum of the liability has not been determined, a fund to meet such present liability cannot be treated as 'reserves'. A fund, however, created for payment of a liability which had not already arisen or fallen due but is only a provision with regard to the sum that might become liable to be paid is 'other reserves' within the meaning of rule 1 of the Second Schedule and should be taken into account in computing the capital of the company for the purpose of the Companies (Profits) Surtax Act, 1964.'

20. These observations leave no manner of doubt that a sum which is set apart to discharge a liability which will arise in future is a reserve.

21. The Supreme Court, once again, had occasion to deal with the question of what is the meaning of the word 'reserve' in the case of Indian Tube Co. P. Ltd. v. CIT : [1992]194ITR102(SC) . In respect of the calendar year 1962, the board of directors on May 1, 1963, approved the transfer of Rs. 90 lakhs out of the profits to the dividend reserve account. In the general meeting held on May 31, 1963, the shareholders declared a dividend of Rs. 76 lakhs. This sum of Rs. 76 lakhs was transferred from the dividend reserve account to the profit and loss appropriation account and the dividend was paid. The question was whether, for the previous year 1963 relevant to the assessment year 1964-65, the entire amount of Rs. 90 lakhs could be included in the capital computation as a reserve for the purposes of the Surtax Act. Approving the decision of the High Court, it was held by the Supreme Court that the resolution of the general body dated May 31, 1963, related back to the calendar year 1962 and, as on January 1, 1963, the sum of Rs. 76 lakhs was a provision and only Rs. 14 lakhs could be treated as a reserve. In arriving at this conclusion, it was observed by the Supreme Court that (at page 106) :

'If an amount is set aside out of profits and other surpluses, not to meet any liability, contingency, commitment or diminution in the value of assets known to exist at the time of the balance-sheet, it was a reserve.'

22. The question whether a debenture redemption fund was a reserve or provision also came up once again before the Calcutta High Court in the case of CIT v. Peico Electronics and Electricals : [1987]166ITR299(Cal) . The Calcutta High Court referred to the decision of the Bombay High Court in National Rayon's case : [1986]160ITR716(Bom) and, following its earlier decision, it concluded as follows (at page 307) :

'On a consideration of the facts of this case, the respective submissions of the parties and the decisions cited before us, it appears that the debenture redemption fund in the instant case fulfills the tests of a reserve in more than one way : (a) the reserve has been created in the instant case out of appropriation from profits and not by way of a charge on the revenue; (b) the fund has been retained to form part of the capital employed in the business, i.e., it has not been invested in securities or otherwise so as to take it out of the business; (c) in the instant case, none of the debentures became redeemable during the accounting period. The liability to redeem the debentures was a future liability; and (d) the debentures had been separately shown in the balance-sheet as a liability.'

23. An attempt was made to distinguish the Bombay High Court decision in National Rayon's case : [1986]160ITR716(Bom) , but it was also observed that (at page 307) : 'With respect, we are unable to agree with the view taken by the Bombay High Court in National Rayon Corporation Ltd. : [1986]160ITR716(Bom) '.

24. In CIT v. Orissa Cement Ltd. : [1980]124ITR251(Delhi) , a Division Bench of this court had to consider whether the gratuity reserve in the balance-sheet of the assessed-company on the first day of the relevant previous year would constitute a 'reserve' includible in the capital base of the company under the provisions of the Super Profits Tax Act, 1963. The assessed had made only an ad hoc allocation of a certain amount which was shown as a gratuity reserve. While coming to the conclusion that the amount set apart by the assessed to meet is liability for gratuity would be a reserve as the setting apart had not been the result of an ascertainment by it of the present value of the future liability, the court specifically referred to and followed the principles enunciated the Supreme Court in Metal Box's case : (1969)ILLJ785SC . It was held that (at page 266) :

'It seems to us that, in deciding the issue before us, it is necessary to bear in mind that the Legislature has chosen not to define the word 'reserve' in this Act. It has, thereforee, to be interpreted very widely on the lines of the dictionary definition, as indicated in Century's case : [1953]24ITR499(SC) as connoting any amount held back or set apart for a specific purpose as at a relevant date. On this interpretation, it is of no consequence what the specific purpose is or how long it is intended to hold back the amounts. But, even if this meaning is considered to be too wide and one proceeds on the basis of the observations of the Supreme Court in Metal Box's case : (1969)ILLJ785SC , as providing a working definition, we think that the expression 'known liability', in the context of the Super Profits Tax Act, should be taken to refer only to a liability existing on the relevant date and not a future liability. We think so having regard to the nature and purpose of the legislation under consideration. The Business Profits Tax Act and the Super Profits Tax Act are pieces of legislation which operate on an annual basis. The purpose of ascertaining the capital is to work out the standard or statutory deduction available to an assessed by reference to the capital and reserves employed by the company in the business in the year of account. Having regard to the fact that this is an annual feature, it appears reasonable to say that what is relevant for the purposes of the computation are amounts which will be in the purposes of the computation are amounts which will be in the coffers of the company for a substantial period of time and are not likely to be frittered or taken away within a short while, if not within the year itself, or within a short period thereafter. For example, where amounts are set apart for payment of income-tax which is a liability in praesenti they would be only in the nature of a provision, for, the liability has already arisen and the amount would have been charged straightaway to the profit and loss account but for the fact that the amount is not definitely known. Or, if, as in Century Spinning's case : [1953]24ITR499(SC) and the Punjab and Haryana High Court case in CIT v. Hindustan Milk Food Mfg. Ltd. the amount is not really held back at all but is on the contrary distributed within a month or so it may not be treated as a reserve. On the other hand, where the purpose of withholding the moneys is to meet a demand which may arise only in the future, it appears reasonable to hold that the amounts constitute 'reserve'. For instance, where a company has borrowed a large sum of money but which is repayable only after a period of 20 years and amounts are set apart by the company from year to year to meet this future liability the funds though set apart in the accounts would continue to be employed in the business for years together and it would be most inappropriate to call it a provision, as would follow if the contention of the Department were accepted. If, in such a case, the company never set apart any sum towards the future liability and merely added to its general reserves, then the liability cannot be deducted in the computation of the capital of the company and it would be illogical, merely because the company set apart year after year some amounts out of its profits to meet the future liability, to treat the amounts set apart as mere provisions and not as reserves. We think that, as rightly pointed out by Shri Desai, counsel for the assessed, the correct test would be whether the amount is set apart towards items whose nature can be described truly as a charge against the annual profits of the company or whether the amounts so set apart continue to be under the proprietorship of the company and capable of being disposed of by it as it likes. In this context, we should not go by the definition in the schedule to the Companies Act. For one thing, unlike the Surtax Act which makes a reference to the definition, the Super Profits Tax Act avoids the incorporation of the said definition and since the Companies Act was of 1956, this must be taken to be deliberate. This apart, the purpose of the definition in the Companies Act is much wider and intended to safeguard the shareholders by ensuring that all possible liabilities of the company are provided for, as provisions to the extent of unforeseeable and unknown liabilities. That special definition may not, thereforee, be imported here, particularly having regard to the object and purpose of the Act as explained earlier. We are, thereforee, of the opinion that the expression 'known liability' should be construed as a reference to liabilities in praesenti and not future liabilities.'

With respect, we are unable to agree with the Bombay High Court that the debenture redemption reserve is a 'provision' and not a 'reserve'. The High Court in National Rayon's case : [1986]160ITR716(Bom) , has observed that (at page 721) : 'the amount set apart to meet a meet a future liability, which was certain to come into existence, as in this case, must be regarded as a provision and not as a reserve.'

25. Our understanding of the judgment in Vazir Sultan's case : [1981]132ITR559(SC) is that the liability must be of the year in question. Accounts are made up annually and 'current liabilities and provisions' must relate to those items which existed as on the last date of the accounting year. True and correct representation of the profits and losses will not be known unless the current liabilities are accounted for. If a definite figure is known, then the same would be regarded as a current liability, but if liability exists, e.g., income-tax or excise duty, but no assessment has been made and the amount determined, then only a 'provision' will have to be made. It is incumbent upon the company to make a provision in its accounts for every liability which exists as on the last date of the accounting year. In respect, however, of a liability which is to arise in the future, even if the amount or extent of liability is known, it is not incumbent on the company to provide for the same in its accounts. However, a company may be prudent enough to keep a sum apart from out of its profits with a view to meet a future liability as and when it arises. The same may be kept apart for a specific purpose, like 'debenture redemption account' which would be a reserve created to meet a future liability or an amount may be transferred from out of its accumulated profits to the general reserve for future utilisation.

26. The matter may be viewed from another angle. What is to be seen, for the purpose of calculating surtax, is the extent of the capital employed in the company. On the figure of capital employed, the company is entitled to a return for the purpose of determination of standard deduction. The capital employed must be used in the business of the company during the year in question. A liability of that year is an outgoing and cannot obviously form part of the 'capital employed' of that year. The said sum, either estimated or an exact amount, representing the liability of a particular year could not possibly be regarded as having been employed by the company as capital during the year. On the other hand 'reserves', whether general or specific, represent money which is available with the company for utilisation during the year. That is the money which belongs to the company and is not owed to anyone, as on the last date of the accounting year. thereforee, even if a liability is to arise in future but if a sum has been set apart for meeting that future liability, the said sum, during the year in which the liability has not arisen, has to be regarded as capital which is employed by the company.

27. It was contended by Shri Rajendra that the decisions of the Calcutta and Karnataka High Courts were clearly distinguishable because, as held by the Bombay High Court in National Rayon's case : [1986]160ITR716(Bom) , the said cases dealt with the question of redeemable performance shares whereas in the present case we are concerned with the redemption of debentures. We, however, find that there is, in principle, no difference between the redemption of preference shares and redemption of debentures. In this regard, reference can usefully be made to the following observations of Gower in his book Principles of Modern Company Law, Fourth Edition, at page 418 :

'The result is, that after lawyers have spent some 50 years trying to teach lay investors that there is a fundamental distinction between preference shares and debentures, the lawyers themselves have ended up by being largely converted to the layman's original view that both are really 'charges' rather than 'equities'. Today, preference shares may be expressly created as redeemable and, even if they are not, it seems that they may be redeemed at the option of the company through the medium of a reduction of capital. And, under the cannone of construction finally adopted, the probability is that they will confer only a right to a fixed return of both dividend and capital. In both respects they closely resemble debentures. Though their holders are members of the company, it is usual to deny them voting their holders are members of the company, it is usual to deny them voting rights except in special circumstances, so that here too they do not greatly differ from debenture holders.'

28. Taking into consideration the various decisions which we have referred to here in above, it appears to us that the current liability as well as provision both relate to the liability of the year in question. The difference between current liability and provision will only be this : in the case of current liability, the extent of the amount of liability is ascertained or known. In the case of a provision, however, though a particular liability may be known, the sum may yet not have been quantified. In the absence of the exact extent of liability being known, an estimated provision has to be made in the accounts of the company. The provision which is so made represents an estimate or the extent of the present liability. If the figure estimated is less than the liability, then it is the excess amount which would be regarded as a reserve. On the other hand, a reserve is a sum which is appropriated from out of the company's profits. It is money which belongs to the company and which it is under no obligation not to use. However, any amount set apart for meeting a future liability will only be regarded as a reserve and not as a provision.

29. What is relevant, thereforee, is that the liability must exist in the year in question. It must be a liability in praesenti and not a liability in future.

30. For the aforesaid reasons, our answer to the question is in the affirmative and in favor of the assessed.

31. There will be no order as to costs. Question answered in the affirmative.