Commissioner Of Income-Tax, Delhi Central v. Modi Spinning & Weaving Mills Co. Ltd.

1. The following questions have been referred by the Income-tax Appellate Tribunal:

" 1. Whether, on the facts and in the circumstances of the case, the assessee can be said to have complied with the provisions of proviso (b) to Section 10(2)(vib) of the Indian Income-tax Act, 1922, and was, therefore, entitled to allowance of development rebate on the plant and machinery installed after January 1, 1958 ?

2. Whether, on the facts and in the circumstances of the case, the expenditure of Rs. 3,000 towards the fees of a lawyer for drafting a special resolution and making amendments to the articles of association was an admissible expenditure within the meaning of Section 10(2)(xv) of the Indian Income-tax Act, 1922 ? "

2. The assessee is a public limited company. During the assessment proceedings for the assessment year 1959-60, for which the relevant previous year ended on April 30, 1958, the assessee claimed development rebate under Section 10(2)(vib)of the Indian Income-tax Ac, 1922, on plant and machinery worth Rs. 7,62,609. The plant and machinery was purchased and installed after January 1, 1958, and before the close of the accounting year. The claim was rejected by the Income-tax Officer on the ground that the assessee had not debited its profit and loss account and created a reserve as required by proviso (b) to Section 10(2)(vib) at the close of the accounting period. The Appellate Assistant Commissioner upheld the rejection of the claim. In second appeal by the assessee, the Income-tax Appellate Tribunal allowed the claim holding that' the assessee was entitled to the benefit of Section 10(2)(vib).

3. During the assessment proceedings before the Income-tax Officer the assessee also claimed the deduction of a sum of Rs. 3,000 paid to a lawyer for drafting a special resolution and suggesting amendments to the articles of association. The Income-tax Officer held that the expenditure was capital in nature inasmuch as it brought into existence an enduring benefit to the assessee. The same view was taken by the Appellate Assistant Commissioner, and affirmed by the Tribunal.

4. In regard to the first question referred, the facts are these. The plant and machinery were purchased and installed between January 1, 1958, and April 30, 1958, but when the accounts were closed and the profit and loss account was drawn up at the end of the accounting year the assessee did not debit in the profit and loss account a sum equal to 75% of the development rebate to be actually allowed and did not credit that sum to a reserve account for being utilised by the assessee for the purposes of the business of the undertaking for the period of ten years next following. In other words, there was no attempt at that time to fulfil the conditions set out in proviso (b) to Section 10(2)(vib), compliance of which was necessary before the development rebate could be allowed. Subsequently, on February 27j 1960, the assessee passed the following resolution in a general meeting;

" Resolved that in order to enable the company to secure exemption from income-tax on Rs. 2,00,000, being the amount of development rebate ' allowable to it on installation of the new plant and machinery during the period from January 1,1958, to April 30, 1958, development rebate reserve be created as required by law to the tune of Rs. 1,50,000 by debit to the profit and loss account and that a sum of Rs. 4,50,000 be transferred from the general reserve to the profit and loss account instead of a sum of Rs. 3,00,000 as in the balance-sheet as on the 30.th April, 1958. Consequent on this, the director's report, the profit and loss account and the balance-sheet, for that year as approved by the company in its general meeting held on January 28, 1959, be amended so as to read as per annexure ' A' to this resolution."

5. Appropriate entries were made in the books of account in accordance with the resolution.

6. When pressing the claim for development rebate before the Income-tax Officer, the assessee relied upon the amendments now effected pursuant to the resolution, but the Income-tax Officer took the view that as the books of the company had already been closed on April 30, 1958, the retrospective amendments sought to be made could not be considered valid. The Appellate Assistant Commissioner pointed out that the debit to the profit and loss account and the corresponding credit to a reserve account -were made after the accounts had been passed in the annual general meeting held on January 28, 1959, and even after the return of income had been filed by the assessee on October 27, 1959. He held that the amendments made subsequently could have no legal effect, When the matter came before the Tribunal, it was urged on behalf of the assessee that even though the conditions of the statute had been belatedly fulfilled the assessee was entitled to have the claim allowed inasmuch as the statutory requirement had been fulfilled before the assessment was taken up. The Tribunal accepted the contention. While declaring that the accounts of a business generally assume finality when the profit and loss account was drawn up and a balance-sheet prepared, it observed that the account could be reopened for the purpose of making necessary adjustments which had been inadvertently left out. It held that as the adjustments were carried out before the claim for development rebate was taken up for consideration by the Income-tax Officer, the assessee should be considered to have fully complied with the requirements for allowing the claim.

7. During the last few years a number of cases have come up before the courts involving the consideration of proviso (b) to Section 10(2)(vib).

8. In Commissioner of Income-tax v. Veeraswami Nainar, [1965] 55 I.T.R. 35, 39 (Mad.), the Income-tax Officer refused to allow development rebate under Section 10(2)(vib). The Appellate Assistant Commissioner found that the assessee had not made the entries required by proviso (b), and affirmed the rejection of the assessee's claim. The Tribunal, however, observed that the statutory requirement was of a " highly theoretical nature ", and it was sufficient if the assessee complied with it even later and made the necessary book entries. The Madras High Court did not accept the view taken by the Tribunal. It pointed out:

" 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 purposes other than those of the business, and if the assessee were a company for exemption, that amount could not tie distributed by way of dividend. It is also clear from the terms of the proviso that the reserve should be made at the time of making up the profit and loss account. The Tribunal was clearly in error when it held that it would be open to the assessee to readjust the account by making the reserve at a later period of time. Any account maintained by a business should reflect its financial transactions correctly. If at the time of the closing of the accounts for a year, a particular appropriation had not been made, but the moneys had been spent otherwise, it would indeed be futile to direct the assessee to readjust the account. For, then, it will not be a true account."

9. It will be noticed that the learned judges were impressed by the consideration that the money necessary for creating a development reserve was not available and, therefore, no readjustment of the account could be contemplated.

10. In Indian Overseas Bank Ltd. v. Commissioner of Income-tax, [1967] 63 I.T.R. 733 (Mad.) the assessee claimed that, because it had set apart for the accounting year as reserve fund, a sum larger than what was required under the Banking Companies Act and the excess was sufficient to cover the proportionate development reserve contemplated by Section 10(2)(vib), it was entitled to the deduction. The claim was repelled by the Madras High Court on the ground that the directors had not specified the purpose for which the money had been set apart. They did not say that the reserve set apart was for the purpose of complying with the provisions of the Banking Companies Act and of Section 10(2)(vib) of the Indian Income-tax Act, 1922. The case, it is clear, was decided on the basis that the entries did not expressly establish compliance with proviso (b) to Section 10(2)(vib).

11. The question before us was discussed at some length by the Andhra Pradesh High Court in Veerabkadra Iron Foundry v. Commissioner of Income-tax, [1968] 69 I.T.R. 425 (A. P.). The assessee there claimed a deduction on account of development rebate, but at the time of making the claim he had not credited any sum-to a reserve fund as required by the provisions of the Act. When the omission was pointed out by the Income-tax Officer in the course of the assessment proceedings, the assessee made the relevant entries debiting the profit and loss account and crediting the development reserve account. The Income-tax Officer disallowed the claim, and his decision was affirmed thereafter by the Appellate Assistant Commissioner and the Tribunal. According to the view taken by those authorities, the entries should have been made before the close of the accounting year. The learned judges of the Andhra Prrdesh High Court, however, pointed out that a profit and loss account was not an account in the sense that it was maintained from day to day in the regular course of business. They observed that it was drawn up only by way of analysis from the primary accounts maintained from day-to-day and, therefore, could be drawn up at any ture and, indeed, it was not possible to draw up such an account before the close of the account year. They held that as the assessee had made the necessary entries before the assessment was finalised by the Income-tax Officer it was entitled to benefit of the rebate.

12. The same view was taken by the Madras High Court in Radhika Mitts Ltd. v. Commissioner of Income-tax, [1969] 74 I.T.R. 661 (Mad.). In this case, the learned judges further explained that the entries could be made only where profits were available for creating the reserve, and that if the profits had already been distributed no question arose thereafter of such reserve being created.

13. The Rajasthan High Court also in Commissioner of Income-tax v. Mazdoor Kisan Sakhari Samiti, [1970] 75 I.T.R. 253 (Raj.) held that if the appropriate entries were made in the accounts at any time before the assessment proceeding was completed the Income-tax Officer could grant the allowance in respect of development rebate.

14. Meanwhile, the decision of the Madras High Court in Indian Overseas Bank Ltd., [1967] 63 I.T.R. 733 (Mad) was taken in appeal to the Supreme Court and that decision was affirmed. We have been referred by the revenue to the following observations of the Supreme Court [197] 77 I.T.R. 512, 514; [1971] 1 S.C R. 38 (S.C.) :

The reserve contemplated by proviso (b) to Section 10(2)(vib) of the Act is an independent reserve. The amount to be transferred to that reserve is debited before the profit and loss account is made up.........As observed by the Madras High Court in Commissioner of Income-tax v. Veeraswami Nainar, [ 1965] 55 I.T.R. 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 purposes other than those of the business and that amount cannot be distributed by way of dividend. It is also clear from the terms of the proviso that the transfer to the reserve fund should be made at the time of making up the profit and loss account.

15. It is urged that the Supreme Court took the view that the entries must be made at the time when the profit and loss account is made up originally and that they cannot be made later. That is how, it is pointed out, those observations were construed by the Gujarat High Court in Surat Textile Mills Ltd. v. Commissioner of lncome-tax, [1971] 80 I.T.R. 1 (Guj.).

16. It seems to us that what the statute contemplates is merely that an amount equal to 75% of the development rebate to be actually allowed should be debited to the profit and loss account of the relevant previous year and credited to a reserve account to be utilised by the assessee during a period of ten years next following for the purposes of the business of the undertaking. The statute does not specify any period of time within which the relevant entries must be made. It is obvious that they cannot be made before the close of the account year. They can be made only after the account year has concluded when it is possible to know the extent of the profits available for the purpose of creating a reserve. It is also clear that the profit and loss account is not in the nature of a day-today account of the business. It is an account prepared for ascertaining the net profit or net loss for an accounting period. It represents the position ascertained upon an analysis of the results of that period. If the profits upon such analysis are sufficient for the purpose of creating a development reserve, such reserve can be created after debiting to the profit and loss account. If profits are not available for that purpose, no such reserve can be contemplated.

17. The board of directors of a limited company prepares a profit and loss account and a balance-sheet so that they can be placed before the shareholders in general meeting to enable the shareholders to know what the financial position of the company is. If the profit and loss account does not contain the entries-required by proviso (b) to Section 10(2)(vib) at the time when it is originally considered by the shareholders, it is open to the shareholders in a subsequent meeting to amend it. This can be done, however, only if it is possible to draw upon available funds for creating the development reserve. If the profits have already been disposed of and it is not possible to draw upon an available source, it is doubtful whether the shareholders can do so. In the case before us, there was sufficiently large general reserve representing undistributed profits, and the assessee by the special resolution of February 27, 1960, decided to draw upon the general reserve for the purpose of augmenting the available profits in the profit and loss account, and creating a development reserve from the additional profits thus available. The assessee created the development reserve without disturbing the distribution of profits already effected earlier. It drew upon the undistributed profits maintained in the general reserve. By the special resolution the assessee amended the directors' report, the profit and loss account and the balance-sheet as on April 30, 1958. It seems to us that the shareholders were entitled to do so.

18. Now, as to the period during which the entries required by proviso (b) to Section 10(2)(vib) must be made, no statutory provision prescribing such period has been placed before us. All that the law requires is that a development reserve be created in compliance with proviso (b), and there is nothing in the object for which the reserve is created from which a definite period for such compliance can be inferred. In our opinion a company may make the necessary entries for the purpose of complying with proviso (b) to Section 10(2)(vib) at any time before the return of income is filed under the Income-tax Act. Even if the entries are made thereafter, during, the pendency of the assessment proceedings, the Income-tax Officer may take them into consideration. As regards the observations of the Supreme Court in Indian Overseas Bank Ltd., [1970] 77 I.T.E. 512 (S.C.) we are unable to infer from them that the profit and loss account originally prepared and passed by a company cannot be subsequently amended by it, and that the Income-tax Officer has no power to allow development rebate if the entries are made after the filing of the original return of income. The revenue relies upon Surat Textile Mills Ltd., [1971] 80 I.T.R. 1 (Guj.) where the Gujarat High Court appears to have taken the view that compliance with proviso (b) to Section 10(2)(vib) cannot be effected after the profit and loss account has once been made up and that subsequent entries debiting the profit and loss account and crediting the development reserve can be of no avail. With great respect to the learned judges who delivered that judgment, we are unable to agree with the view taken by them. The learned judges have supported their decision by reference to the observations of the Madras High Court in Vesraswami Nainar, [1965] 55 I.T.R. 35 (Mad.) and Indian Overseas Bank Ltd., [1967] 63 I.T.R. 733 (Mad.) as well as of the Supreme Court [1970] 77 I.T.R. 512 (S.C.) in the appeal from the latter decision. But, we have been unable to read those observations in the same light. Apart from this we may point out that the learned judges of the Gujarat High Court found that the debit was made to the profit and loss account for the year 1961 instead of that for the year 1960 which was the appropriate year.

19. Accordingly, we hold that the assessee must be taken to have complied with the provisions of proviso (b) to Section 10(2)(vib) of the Indian Income-tax Act, 1922, and it was, therefore, entitled to the allowance of development rebate on the plant and machinery installed after January 1, 1958. The first question referred is answered in the affirmative.

20. In regard to the second question, the amount of Rs. 3,000 was paid to a lawyer for advising amendments in the articles of association and for drafting a special resolution. The articles of association had to be amended in order to bring it into accord with changes brought about in the law relating to companies. It seems to us that the expenditure was incurred by the assessee wholly and exclusively for the purpose of its business. It was incurred in order that the company should continue to function in accordance with the law. Nothing has been shown to us to indicate that the expenditure was capital in nature. The second question referred is, therefore, answered in the affirmative.

21. The assessee is entitled to its costs, which we assess at Rs. 200. Counsel's fee is assessed in the same figure.