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Commissioner Of Income-Tax, U.P v. Security Printers Of India (P.) Ltd.
Structured Summary of the Court's Opinion
Factual and Procedural Background
The Income-tax Appellate Tribunal referred the following question for determination:
"Whether, on the facts and in the circumstances of the case, it could be held that the provision for bonus, provision for taxation and provision for proposed dividends represented 'reserves' and were to be included in the computation of capital under the Super Profits Tax Act, 1963?"
The assessee is a private limited company. For the assessment year 1963-64 (previous year ending March 31, 1963), the assessee claimed that three items shown in its accounts should be treated as reserves for the purposes of computing capital under the Super Profits Tax Act, 1963:
- Provision for bonus: Rs. 5,000
- Provision for taxation: Rs. 81,000
- Provision for proposed dividends: Rs. 52,500
The Income-tax Officer rejected the claim on the ground that these amounts were designed to meet contingent liabilities and therefore could not be treated as reserves. The Appellate Assistant Commissioner affirmed that decision. The Tribunal, after examining the assessee's balance-sheet and the nature of the three provisions, held that they fell within the meaning of "reserves", noting that the items had been debited to the profit and loss account and had not been allowed as deductions for income-tax purposes. The Tribunal allowed the appeal and directed that these items should be treated as reserves and included in the computation of the assessee's capital for super profits tax. The Commissioner of Income-tax procured the present reference from the Tribunal.
Legal Issues Presented
- Whether the provision for bonus, provision for taxation and provision for proposed dividends represented "reserves" and therefore were to be included in the computation of capital under the Second Schedule (Rule 1) to the Super Profits Tax Act, 1963.
Arguments of the Parties
Assessee's Arguments
- The three items (provision for bonus, taxation and proposed dividends) should be considered reserves when computing capital under the Super Profits Tax Act, 1963.
- There was no dispute that these amounts had been debited to the profit and loss account and had not been allowed as deductions for income-tax purposes.
Revenue's Arguments
- The Income-tax Officer contended that the amounts were designed to meet contingent liabilities and therefore could not be treated as reserves.
- Before the Tribunal, the Revenue contested classification of the items as reserves (although it accepted they were not allowed as deductions). The Revenue sought to raise additional points before the Court (e.g., that the amounts might represent liabilities already arisen or that reservation was not properly authorised), but the Court declined to permit these points because they had not been raised before the Tribunal.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Commissioner of Income-tax v. Century Spg. & Mfg. Co. Ltd., [1953] 24 I.T.R. 499, 503; [1954] S.C.R. 203 (S.C.) | Defined "reserve" (using dictionary meanings) as profit earned by a company and not distributed as dividend but kept back by directors for future use. | The Court adopted the Century definition as the controlling test of "reserve" and relied on it to assess whether the three provisions were sums kept back for future use. |
| First National City Bank v. Commissioner of Income-tax, [1961] 42 I.T.R. 17; [1961] 3 S.C.R. 371 (S.C.) | Applied and reaffirmed the ordinary meaning of "reserve" as something kept apart for future use. | The Court cited this case as a reaffirmation of Century and as supporting the ordinary-meaning test applied to the facts. |
| Commissioner of Income-tax v. Standard Vacuum Oil Co., [1966] 59 I.T.R. 685, 698 (S.C.) | Re-affirmation that "reserve" in ordinary meaning is something specifically kept apart for future use or a specific occasion. | Used to reinforce the interpretive principle that reserves must be sums set apart for future application. |
| Commissioner of Income-tax v. Bank of Bihar Ltd., [1953] 24 I.T.R. 9 (Pat.) | Described commercial practice where directors may appropriate profit balances to reserves for acquiring property, meeting contingencies, equalising dividends, or other company purposes. | Cited to show commercial practice and that appropriation by directors to reserves for specified uses is consistent with the concept of "reserve". |
| Commissioner of Income-tax v. Vasantha Mills Ltd., [1957] 32 I.T.R. 237 (Mad.) | Held that a provision set apart for payment of taxes (a specified sum for a specified use) qualified as a "reserve" under Rule 2(1) of the Second Schedule to the Business Profits Tax Act. | The Court relied on this decision to support treating a provision for taxation as a reserve when a specified sum is validly set aside for that purpose. |
| Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax, [1958] 33 I.T.R. 579 (Cal.) | Explained that a reserve is a fund created and maintained to be drawn upon in future, normally created out of surplus profits and set aside against anticipated contingencies. | Used to elaborate the nature of reserves as funds created against future contingencies and to support the conclusion that provisions for anticipated liabilities can be reserves. |
| Aluminium Industries Ltd v. Commissioner of Income-tax, [1968] 68 I.T.R. 125 (Ker.) | Considered the meaning of "reserve" in Rule 1 of the Second Schedule to the Super Profits Tax Act and applied the Supreme Court test from Century Spg. & Mfg. Co. | Cited as a directly relevant High Court decision applying the same test under the Super Profits Tax Act; the Court noted that considerations under the Super Profits Tax Act were substantially the same as under the Business Profits Tax Act. |
Court's Reasoning and Analysis
The Court proceeded through the following analytical steps, relying strictly on the text of the opinion and cited authorities:
- Statutory context: The Super Profits Tax Act imposes a tax measured by chargeable profits in excess of a "standard deduction" equal to six percent of the company's capital (or Rs. 50,000, whichever is greater). The Second Schedule, Rule 1, prescribes how "capital" is computed and expressly includes paid-up share capital and certain reserves, including "other reserves" to the extent that amounts credited to such other reserves have not been allowed in computing profits for income-tax purposes.
- Characterisation issue: The three items in question were not reserves of the specific statutory types referred to in the provisos (i.e., reserves created under particular provisions of older Income-tax Acts), so the determinative question was whether they fell within the phrase "other reserves" in Rule 1.
- Interpretive test: The Court adopted the test from the Supreme Court's Century decision and subsequent authorities: "reserve" in this context must be understood in its ordinary meaning — a sum specifically kept apart from profits, not distributed as dividend, and retained by the directors for future use or for a specified purpose. The Court reiterated dictionary meanings and cited multiple authorities which define a reserve as a fund set aside for future use or against anticipated contingencies.
-
Application to factual matrix: Applying that test to the facts before it, the Court noted that the three items (bonus provision, taxation provision, and proposed dividends provision) were:
- specifically set apart to meet future liabilities;
- debited to the profit and loss account of the relevant year; and
- not allowed as deductions for income-tax purposes.
- Conclusion from application: Given that the amounts were sums set aside by the requisite authority for specified future liabilities and satisfied the ordinary-meaning test of "reserve" as developed in precedents, the Court held they qualified as "reserves" under Rule 1 of the Second Schedule to the Super Profits Tax Act and therefore had to be included in the capital computation for the purposes of super profits tax.
Holding and Implications
Holding: The question referred is answered in the affirmative: the provision for bonus, the provision for taxation and the provision for proposed dividends are to be treated as "reserves" for the purposes of Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, and must be included in the computation of the company's capital under that provision.
Direct implications and consequences:
- The three specified items (Rs. 5,000; Rs. 81,000; Rs. 52,500) must be included when computing the assessee's capital for the Super Profits Tax Act, thereby affecting the calculation of the standard deduction and hence the super profits tax liability for the relevant assessment year.
- The Court awarded costs to the assessee in the amount of Rs. 200, and assessed counsel's fee at the same figure.
Broader implications: The opinion applies and reaffirms established precedents about the ordinary-meaning test of "reserve" as a sum kept apart for future use; it does not purport to establish a novel legal principle beyond applying those precedents to the facts of this case.
1. The Income-tax Appellate Tribunal has referred the following question ;
"Whether, on the facts and in the circumstances of the case, it could be held that the provision for bonus, provision for taxation and provision for proposed dividends represented 'reserves' and were to be included in the computation of capital under the Super Profits Tax Act, 1963 ?"
2. The assessee is a private limited company. During assessment proceedings under the Super Profits Tax Act, 1963, for the assessment year 1963-64 (the relevant previous year being the financial year ending March 31, 1963), the assessee claimed that the following three items of reserves should be considered while computing its capital investment.
(a) provision for bonus Rs. 5,000
(b) provision for taxation Rs. 81,000
(c) provision for proposed dividends Rs. 52,500
3. The Income-tax Officer rejected the claim on the ground that these amounts were designed to meet a contingent liability and, therefore, could not be treated as reserves. The Appellate Assistant Commissioner of Income-tax affirmed the decision. The Tribunal examined the balance-sheet of the assessee, and upon a consideration of the nature of the provision for bonus, taxation and proposed dividends, held that they fell within the meaning of the expression "reserves". There was no dispute before the Tribunal that the three items had been actually debited to the assessee's profit and loss account and had not been allowed as a deduction for the purposes of income-tax assessment. Accordingly, the Tribunal allowed the appeal and directed that the three items should be treated as "reserves" and included in the computation of the capital of the assessee for the purposes of super profits tax. At the instance of the Commissioner of Income-tax, the Tribunal has now made the present reference.
4. The Super Profits Tax Act, 1963, enacted by Parliament, imposes a special tax on certain companies. Section 4 charges the tax on every company for every assessment year from April 1, 1963, in respect of so much of the chargeable profits of the previous year as exceed the standard deduction at the rates specified in the Third Schedule. The expression "standard deduction" is defined in Section 2(9) as "an amount equal to six per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of fifty thousand rupees, whichever is greater. The Second Schedule contains rules for computing the capital of a company for the purposes of super profits tax, and Rule 1 declares :
"Subject to the other provisions contained in this Schedule, the capital of a company shall be the sum of the amounts, as on the first day of the previous year relevant to the assessment year, of its paid up share capital and of its reserve, 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, 4961 (43 of 1961), and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961), diminished by the amount by which the cost to it of the assets the income from which in accordance with Clause (iii) or Clause (vi) or Clause (vii) of Rule 1 of the First Schedule is not includible in its chargeable profits, exceeds the aggregate of--
(i) any money borrowed by it which remains outstanding ; (ii) the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under this rule ......"
5. For the purpose of Rule 1 the reserves of the company must be added to its paid up capital. The reserves are those specified by the rule.
6. Admittedly, the provision for bonus, for taxation and for proposed dividends are not reserves contemplated under proviso (b) to Section 10(2)(vib) of the Indian Income-tax Act, 1922, or Section 34(3) of the Income-tax Act, 1961. The case of the assessee is that they represent other reserves the amounts of which have not been allowed in computing the assessee's profits for the purposes of the Indian Income-tax Act, 1922, or the Income-tax Act, 1961. For the revenue, while it is not disputed that the amounts represented by the three items have not been allowed in computing the assessee's profits for the purposes of either of the Income-tax Acts, it is contended that the three items cannot be described as reserves :
What then is a "reserve" for the purpose of Rule 1 ?
7. The Supreme Court in Commissioner of Income-tax v. Century Spg. & Mfg. Co, Ltd., [1953] 24 I.T.R. 499, 503 ; [1954] S.C.R. 203 (S.C.).
considered a somewhat comparable provision of the Second Schedule to the Business Profits Tax Act, 1947.
8. Rule 2(1) of that Schedule read :
"Where the company is one to which Rule 3 of Schedule I applies, its capital shall be the sum of the amounts of its paid-up share capital and of its reserves in so far as they have not been allowed in computing the profits of the company for the purposes of the Indian Income-tax Act, 1922. ..."
9. The Supreme Court observed :
"The term 'reserve' is not defined in the Act and we must resort to the ordinary natural meaning as understood in common parlance. The dictionary meaning of the word 'reserve' is :
'1(a) To keep for future use or enjoyment; to store up for some time or occasion ; to refrain from using or enjoying at once.'
(b) To keep back or hold over to a later time or place or for further treatment.
6. To set apart for some purpose or with some end in view ; to keep for some use.
11. To retain or preserve for certain purposes.' (Oxford Dictionary, Vol. VIII, p. 513).
10. In Webster's New International Dictionary, second edition, page 2118, 'reserve' is defined as follows:
'1. To keep in store for future or special use ; to keep in reserve; to retain, to keep, as for oneself.
2. To keep back; to retain or hold over to a future time or place.
3. To preserve.'"
11. And then it said ;
"Reserve in the sense in which it is used in Rule 2 can only mean profit earned by a company and not distributed as dividend to the shareholders but kept back by the directors for any purpose to which it may be put in future."
12. This test was applied by the Supreme Court in First National City Bank v. Commissioner of income-tax, [1961] 42 I.T.R. 17 ; [1961] 3 S.C.R. 371(S.C.) and again in Commissioner of Income-tax v. Standard Vacuum Oil Co., [1966] 59 I.T.R. 685, 698 (S.C.)where it re-affirmed that;
"In its ordinary meaning, the expression 'reserve' means something specifically kept apart for future use or for a specific occasion."
13. We shall now turn to some decisions of the High Courts in this country. The Patna High Court, in Commissioner of Income-tax v. Bank of Bihar Ltd., [1953] 24 I.T.R. 9 (Pat.)said:
" According to commercial practice a company which has a balance to the credit of its profit and loss account may either declare a dividend to be paid to the shareholders or may appropriate the balance to a suspense account or to reserves. Before recommending any dividend it is open to the directors to set aside out of the profits of the company such sum as they might think proper as a reserve fund for acquiring property for the company or providing for payment of rent for meeting contingencies or for equalising dividends or for any other purpose of the company which they may think fit."
14. In Commissioner of Income-tax v. Vasantha Mills Ltd., [1957] 32 I.T.R. 237, 251 (Mad.) the Madras High Court upheld the assessee's claim that a sum of Rs. 9,00,000 shown as provision made in the relevant year of account for the payment of income-tax and excess profits tax should be treated as a reserve for the purposes of Rule 2(1) of the Second Schedule to the Business Profits Tax Act. The learned judges observed :
......that the sum of Rs. 9,00,000 was set apart for a specified purpose with a specified end in view, payment of taxes when they fell due. Reservation of a specified sum for a specified use, when the reservation has been validly made by a person having authority to do so, would appear to bring the sum so reserved within the meaning of the expression 'reserve' in Rule 2(1).
15. They held that the allocation of a specified sum out of the profits of the company kept back for utilisation towards the payment of tax was sufficient to make the sum so set apart a reserve within the meaning of Rule 2(1). It was set apart for some purpose and was kept for some use, the purpose and use having been specified when the sum was allocated and "reserved" for the payment of tax. What constitutes a reserve under Rule 2(1) of the same Schedule was considered by the Calcutta High Court also. In Indian Steel and Wire Products Ltd. v. Commissioner of Income-tax, [1958] 33 I.T.R. 579, 584, 588 (Cal.) Chakravarti C.J, with whom Guha J. agreed, observed :
. . . . it can hardly be disputed that nothing can be reserved unless it has been reserved or laid by or stored for use or application in a future contingency which is anticipated as certain or likely. In the actual administration of companies also a part of the surplus profits is removed from the immediate business of the company by way of a provision against future contingencies and a reserve is thus created, although after being carried to the reserve, the amount in question may be invested or re-employed in the business, if the articles so permit.
16. Elaborating further, he said:
"A reserve as I have endeavoured to explain is by its very nature a fund which is created and maintained for the purpose of being drawn upon in future. .... A reserve is created only out of the whole or a part of the surplus profits as they are found to be in the hands of the company at the end of the year and it is a reserve against a contingency which still lies in the future."
17. Our attention was drawn on behalf of the revenue to Aluminium Industries Ltd v. Commissioner of Income-tax, [1968] 68 I.T.R. 125 (Ker.) where the Kerala High Court considered the meaning of the expression "reserve" in Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963, the question with which we are concerned. The High Court applied the test propounded by the Supreme Court in Century Spg, & Mfg. Co. case, holding that the considerations governing the question under the Super Profits Tax Act were substantially the same as those under the Business Profits Tax Act.
18. From the cases referred to, one thing is clear. And that is that the term "reserve" means a sum specifically kept apart for future use or for a specific occasion. The reservation must be effected by some one having authority to do so, and it must be of a specified sum for a specified use, Where it arises out of the surplus profits of the company, it should be set apart before the distribution of dividends to the shareholders. It is a sum laid by or stored for use or application in a future contingency which is anticipated, a fund which is created and maintained for the purpose of being drawn upon in future.
19. Upon the facts before us it is clear that the three items, provision for bonus, for taxation and for proposed dividends represent amounts specifically set apart for meeting future liabilities. It does not appear that the revenue ever contended before the Tribunal that the amounts represent liabilities which had already arisen during the relevant previous year and were not intended for a future contingency. Nor was it questioned that the provision was made by the requisite authority. An attempt has been made before us on behalf of the revenue to raise those questions, but we are unable to permit those points to be raised as they were not raised before the Tribunal. There is no dispute that the three items have actually been debited to the assessee's profit and loss account and that they have not been allowed as a deduction for the purposes of income-tax assessment.
20. In our opinion, the provision for bonus, the provision for taxation and the provision for proposed dividends are entitled to be treated as "reserves" for the purposes of Rule 1 of the Second Schedule to the Super Profits Tax Act, and they should be included in the computation of capital under that provision.
21. The question referred is answered in the affirmative.
22. The assessee is entitled to its costs, which we assess at Rs. 200. Counsel's fee is assessed in the same figure.
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