Y. Upadhyay, Vice President -
(1.) THESE two appeals are taken - together and disposed of by a common order.
(2.) The assessee is a limited company. Appeal No. 4 (Cal.) of 1981 arises out of the order of the Commissioner under Section 16(1) of the Companies (Profits) Surtax Act, 1964 ('the Act'). Appeal No. 34 (Cal.) of 1981 arises out of the order of the ITO who re-made the assessment after the order of the Commissioner under Section 16(1) of the Act.
The assessee-company filed its return under the Act showing the chargeable profit of Rs. 1,28,87,153 on 30-9-1975. The ITO computed the capital of the company for the purpose of allowing statutory deduction at Rs. 5,87,75,312. He allowed the statutory deduction, at 10 per cent of the above amount, at Rs. 58,77,531. He calculated the gross chargeable profit of Rs. 2,27,17,219 and after deducting the standard deduction of Rs. 58,77,531 determined the net chargeable profit at Rs. 1,68,39,688. The Commissioner perused the record of the ITO and found that the order passed by the ITO was erroneous and prejudicial to the interest of the revenue. He, therefore, issued a notice under Section 16. The Commissioner stated that the ITO in determining the capital base for arriving at the standard deduction for the year included the debenture stock redemption reserve and the full amount standing in the general reserve account. The inclusion of the sum of Rs. 24 lakhs on account of the debenture stock redemption reserve, was erroneous. He further indicated that the full amount of general reserve, as on 1-1-1974, could not have been considered for inclusion, inasmuch as the proposed dividend of Rs. 24,32,250, for the year 1973, was to be paid from the general reserve. Therefore, the inclusion of the amount was also erroneous. The assessee's representative pleaded before the Commissioner that the general reserve was rightly taken so far as the amount of dividend of Rs. 24,32,250 was concerned. However, on the debenture stock redemption reserve, he stated that the debenture stock redemption reserve as appearing in the balance sheet of the company was not hit by any of the provisions of the Explanation to Rule 1 of the Second Schedule of the Act, and that the accumulation, out of the appropriation of the profits for the earlier years, towards this reserve had not been separately invested or separately kept as a fund and further that such accumulation had been part of the total assets of the company and had remained as its current assets and, therefore, the debenture stock redemption reserve is in no way different from the general reserve and, as such, it should rightly be included as part of its capital. It was further stated that after the debenture stock, in respect of which the debenture stock redemption reserve has been created, has been repaid in due time, the debenture stock redemption reserve will have to be transferred to the general reserve. The Commissioner first discussed the history of the debenture issued by the assessee-company and then proceeded to consider the arguments. He first considered whether the debenture stock redemption reserve created by the assessee could be treated as a 'sinking fund'. The conclusion of the Commissioner was against the assessee. He was also not agreeable with the assessee that the debenture stock redemption reserve was a reserve of the assessee. He further found that even a part of the debenture stock redemption reserve was not invested by the assessee. The Commissioner had discussed three arguments of the assessee -in paragraphs 7 and 8 of his order as follows :
7. One of the questions that arises is whether the debenture stock redemption reserve is in effect a 'sinking fund' as appearing in the form of balance sheet under Schedule VI to the Companies Act, 1956 and whether it is thus coming under Item 7 under the head 'Reserves and Surplus' on the liabilities column (side) of the form of balance sheet. If so, it would be hit by the Explanation to Rule 1 of the Second Schedule of the Companies Profits Surtax Act. However, 'the instructions in accordance with which liabilities should be made out' as given in the form of balance sheet is that the word 'fund' in relation to any 'Reserve' should be used only where such Reserve is specifically represented by earmarked investments. In the present case, there have been no such earmarked investments relating to the debenture stock redemption reserve and in that view of the matter it cannot be treated as a sinking fund.
8. The next question is whether notwithstanding the use of the expression 'Reserve', the amounts to the credit of the Debenture Stock Redemption Reserve constitutes really a Reserve. Part III (the interpretation clauses of Schedule VI of the Companies Act) of Schedule VI of the Companies Act throws some light on the matter. Rule 7(1)(&) says that the expression 'Reserve' shall not include any amount retained by way of providing for any known liability. The expression 'provision' is defined in Rule 7(1)(a) to mean any amount retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.
In the circumstances of this case, the provisions of Rs. 6 lakhs out of the profits for the Debenture Stock Redemption Reserve can be said to be a provision towards a known liability arising out of contract. It cannot therefore be treated as 'Reserve' for computing the capital for the purposes of the Surtax Act. The point that the Debenture Stock Redemption Reserve, on re-payment or redeeming the debenture stock would be closed by transfer to the general reserve does not have any special bearing inasmuch as even in a case where there is a Debenture Stock Redemption Reserve Fund or Debenture Stock Sinking Fund, such a Fund will be closed, according to all standard works on accountancy, by transfer to the general reserve. (The fund account which figures on the assets side will be wiped out along with the Debenture Stock account, which figures on the liabilities side.) Such a Debenture Stock Sinking Fund cannot be treated as part of the Reserve for capital computation in view of the Explanation below Rule 1 of the Second Schedule to the Surtax Act. Besides, whether an earmarked Fund has been created or not, really makes no difference because the income from the Fund as such will form part of the income of the Company, even in a case where the Fund is kept deposited with a Bank inasmuch as the ownership of the Fund continued with the Company.
He, accordingly, came to the conclusion that the order of the IT O was erroneous as the ITO had not reduced the general reserve by Rs. 24,32,250 and Rs. 24,00,000. He, therefore, directed the ITO to exclude these amounts from the computation of capital and modify the assessment accordingly.
(3.) SHRI B.D. Nagpal, the counsel of the assessee, filed a paper book which included the Directors' Reports, Balance Sheet and profit & loss account for the year ended 31-12-1974, Schedules 2 and 3 of the Balance Sheet and extract from Book-Keeping and Accountancy by Spicer and Peigler at pages 270 to 271, 157 to 159 and 356. On the basis of these papers, the assessee's counsel stated that the debenture stock redemption reserve was only a reserve within the meaning of the Act and, therefore, the ITO was correct in not excluding the amount while computing the capital for the purposes of standard deduction. He referred to the decision of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT  132 ITR 559 at page 569, and urged that the Supreme Court had occasion to consider the distinction between a provision and a reserve. If the principle laid down by the Supreme Court is taken into consideration, the debenture stock redemption reserve was only a reserve and it was not a provision. He stated that this reserve has been created not out of the profits and loss account of the assessee but the reserve has been created out of the appropriation account. In this connection, he referred to the directors' report on page I of the paper book as well as the appropriation account appearing on page 3 and also Schedule 2 on page 4 for reserve and surplus. Referring to these pages, the counsel of the assessee stated that it is evidently clear that the debenture stock redemption reserve has been appropriated out of the profit and the reserve has not been created in the profit and loss account. It was stated that, the assessee-company has already issued debentures for which debenture account has been credited and, therefore, the assessee could not have credited the same account by debiting the amount in the profit and loss account. Therefore, the reserve created by the assessee was only out of the surplus profit. The reserve did not create any charge on the profit of the assessee. He also referred to Schedule II to the Act, the Companies Act, 1956 and Clause 7 of Part III of Schedule VI to the Companies Act, 1956 and stated that if these provisions are taken into consideration, the debenture stock redemption fund was only a reserve, and therefore, the ITO was justified in not excluding the amount. He further referred to the Balance Sheet and urged that the general reserve is to be taken as it was on 1-4-1974, whereas the dividend pertained for the year 1973 and, therefore, the ITO was justified in not excluding the sum of Rs. 24,32,250.;