Citation Codes

Equivalent Citations

citation codes

Case Number

Income-tax Reference No. 717 of 1974

Judges

Satish Chandra, C.J
K.C Agrawal, J.

Acts

available.16. Section 34(3)(a) opensThe deduction referred to in section 33
provisions are ss. 33 and 34(3)(a) of the I.T Act, 1961. Section 33(1)(a)
development.12. Sub-section (2) of s. 33
s. 17 of the Banking Companies Act.
years.14. Sub-section (2)
him.5. Section 34(3)(a)
FINANCE ACT 1966

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Smart Summary

Structured Summary of the Court's Opinion

Factual and Procedural Background

Vishnu Industrial Enterprises (Private) Ltd., Kanpur (the assessee) suffered losses in the assessment years 1967–68 and 1968–69 but claimed development rebate in respect of plant and machinery installed in those years. The Income-tax Officer (ITO) rejected the claim on the ground that the assessee had not debited the profit and loss account nor created the statutory development reserve. The ITO applied the Supreme Court's decision in Indian Overseas Bank Ltd. v. Commissioner of Income Tax, Madras and disallowed the development rebate.

On appeal, the Appellate Assistant Commissioner (AAC) held that because there were no profits the reserve could not be created in those years, but that the development rebate should nevertheless be calculated in the year of installation and allowed in a succeeding year in which the assessee earned profits and created the requisite reserve. The ITO appealed; the Tribunal affirmed the AAC's view.

The Commissioner referred the following question of law to the Tribunal for opinion: whether the Appellate Tribunal was correct in upholding the direction to the ITO to determine the development rebate admissible for the years 1967–68 and 1968–69 when the assessee had suffered losses and had not created the statutory reserve, and whether the rebate should be carried forward and allowed in years in which profits arise and the reserve is created.

Legal Issues Presented

Whether, on the facts and in the circumstances of this case, the Appellate Tribunal was correct in upholding the direction that the ITO determine the development rebate admissible to the assessee for the years 1967–68 and 1968–69 when, in those years, the assessee suffered losses and had not created the statutory reserve, and whether the rebate may be carried forward and allowed in subsequent years when profits and the reserve occur.

Arguments of the Parties

Assessee / Appellant (as reflected in the AAC and Tribunal findings)

The development rebate should be calculated in the year of installation (the first year) even if there are losses in that year; the rebate can be carried forward and allowed in a subsequent year when assessable profits arise and when the statutory reserve can be created (i.e., debiting profit & loss and crediting reserve).
Where profits are not available in the year of installation, the reserve cannot practically be created out of profits, and forcing creation out of capital or borrowings would defeat the purpose of the rebate (accumulating funds for development).

Revenue / Department (as presented in the opinion)

The ITO initially relied on the Supreme Court decision in Indian Overseas Bank Ltd. v. CIT, applying it to deny the rebate where the assessee had not debited the profit and loss account and had not created the reserve.
Learned counsel for the department relied on the Gujarat High Court decisions (notably Addl. CIT v. Shri Subhlaxmi Mills) arguing that the legislature intended the reserve to be created irrespective of whether surplus profit was available, so that allowing the rebate only in later years would conflict with the statutory scheme.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Indian Overseas Bank Ltd. v. Commissioner of Income Tax, Madras, [1970] 77 ITR 512 (SC)	Interpretation that 75% of the development rebate must be debited to the profit & loss account and transferred to a reserve at the time of making up the accounts; creation of reserve is not idle formality and is traceable by the ITO.	The Court recognized the decision, explained its holding, and observed that the Supreme Court in that case was not concerned with the question of the timing/year in which the reserve must be created; the opinion distinguishes the procedural point (timing) and applies the rationale without adopting an inflexible timing rule that defeats carry-forward.
Navnit Lal C. Javeri v. K.K. Sen, [1965] 56 ITR 198 (SC)	Principle that income-tax authorities are bound by Board circulars and such circulars are to be given effect by courts.	Used to support the weight given to the Board of Direct Taxes' circulars in interpreting the statutory scheme governing development rebate and reserve creation.
Ellen-man Lines Ltd. v. CIT, [1971] 82 ITR 913 (SC)	Similar principle that authorities and courts should give effect to Board circulars.	Invoked to reinforce that the Board's explanatory circulars are entitled to effect and support the Court's interpretation.
West Laikdihi Coal Co. Ltd. v. CIT (Calcutta High Court), [1973] 87 ITR 501	High Court decision supporting the view that rebate can be carried forward and the reserve need not be created in the first year when there are no profits.	Relied on as consistent high court authority backing the opinion given in favour of the assessee.
Indian Oil Corporation Ltd. v. S. Rajagopalan, ITO (Bombay High Court), [1973] 92 ITR 241	High Court decision supporting the view in favour of carry forward and practical creation of reserve when profits are available.	Noted as supporting the Court's approach.
Tata Iron & Steel Co. Ltd. v. N.C. Upadhyaya (Bombay High Court), [1974] 96 ITR 1	High Court decision consistent with allowing carry forward of unabsorbed development rebate.	Cited as reinforcing the Court's interpretation.
CIT v. Narula Cold Storage & Ice Factory (Orissa High Court), [1976] 104 ITR 148	High Court authority supporting the permissibility of carry forward and later creation/utilisation of reserves.	Referenced as supporting the view adopted by the Court.
Radhika Mills Ltd. v. CIT (Madras High Court), [1969] 74 ITR 661	High Court decision consistent with the position taken by the Court in this opinion.	Noted as supportive authority.
Surat Textile Mills Ltd. v. CIT (Gujarat High Court), [1971] 80 ITR 1	High Court decision taking a contrary view (emphasising that reserve creation should be irrespective of profit availability and cautioning about prolongation of reserve use).	The Court disagreed with this contrary view and explained why it considered that approach unsound in the context of the statutory scheme.
Addl. CIT v. Shri Subhlaxmi Mills, [1975] 100 ITR 188 (Gujarat High Court)	Gujarat High Court decision relied on by the department to contend reserve must be created irrespective of profit availability.	The Court considered this authority but rejected its application, explaining the legislative intent of the explanatory provision and the carry-forward scheme in s.33(2).

Court's Reasoning and Analysis

The Court's analysis proceeded from a close reading of the statutory scheme and related materials:

Statutory provisions: The Court recited ss. 33 and 34(3)(a) of the Income-tax Act, 1961. Section 33(1)(a) allows a development rebate in the previous year in which plant or machinery was installed. Section 34(3)(a) sets conditions for the deduction, notably that 75% of the rebate actually allowed should be debited to the profit & loss account of the relevant previous year and credited to a reserve account to be utilised for business purposes over eight years (with specified prohibitions).
Explanation to s.34(3)(a): The Explanation (added by Finance Act, 1966, with retrospective effect) declared that the deduction shall not be denied solely because the amount debited and credited exceeds the profit of that previous year (i.e., some apparent mismatch between profit and the bookkeeping entries should not automatically result in disallowance).
Interpretation of Indian Overseas Bank decision: The Court accepted the principles in Indian Overseas Bank (that debiting 75% and transferring to reserve are formal requirements and that the reserve is intended to be traceable and used for development), but it emphasised that the Supreme Court in that case was not concerned with the question of the timing of reserve creation. Thus the Bank decision does not mandate denial of rebate in every case where reserve creation did not occur in the first year.
Functional and purposive reading: The Court observed the development rebate is an incentive to industrial expansion, not a yearly expenditure allowance. It is actual money intended for development use over eight years and is allowable only once; it is distinct from depreciation which is annual.
Practicality and statutory harmony: There is no express provision that the reserve must be created in the year for which the rebate is determined. Since a reserve can realistically only be created out of profits, forcing creation in a loss year (out of capital or borrowings) would defeat the objective of allowing accumulation of funds for development. Sub-section (2) of s.33 expressly contemplates carry forward of unabsorbed development rebate where total income in the first year is nil or less than the rebate, and provides for carry forward for up to eight years.
Consequence for administration: The cost basis (cost of plant/machinery) necessary to calculate the allowable development rebate is available in the first year, so the ITO can determine the allowable amount in that year even if actual adjustment must await assessable income in later years.
Temporal operation of s.34(3)(a): That subsection "comes into play at the time of actual allowance" — the conditions precedent (debited to profit & loss and credited to reserve) must be complied with at the time the rebate is actually allowed. Thus where profits are absent in the first year the full reserve cannot be created; partial creation and phased creation across years (as profits permit) is consistent with the carry-forward scheme.
Administrative guidance and secondary materials: The Board of Direct Taxes' Circular F. No. 10/49/65-ITA-I (14 Oct 1965) and Circular No. 189 (30 Jan 1976) were considered. The Board clarified (a) limited exceptions where pre-existing development reserves could be treated as including the statutory reserve (superseded by the Supreme Court decision), and (b) that where total income prior to allowing the rebate is a loss there is no legal obligation to create the statutory reserve in that year and that genuine deficiencies could be condoned subject to rectification. The Court treated those circulars as entitled to effect, relying on Supreme Court authorities to that effect.
Treatment of contrary authorities: The Court examined Gujarat High Court authorities which had taken a contrary view, observing the Gujarat High Court's concern about prolongation of reserve utilisation. The present Court rejected that position, explaining that the statutory carry-forward is limited to eight years and that potential extreme factual sequences (e.g., losses for seven years) do not justify denying the carry-forward in ordinary cases.
Conclusion of legal reasoning: The proper procedure is that the development rebate should be determined in the first year (based on cost). Actual adjustment (allowance) depends on the availability of assessable income and can be made in subsequent years when profits permit creation of the statutory reserve by debiting profit & loss and crediting the reserve account to the extent income permits. Therefore, in loss years the ITO should determine the rebate but allow its adjustment in later profitable years in conformity with s.33(2) and the conditions of s.34(3)(a).

Holding and Implications

Holding:

The Court answered the referred question in the affirmative in favour of the assessee and against the department. The assessee is entitled to have the development rebate determined for the years 1967–68 and 1968–69 and the unabsorbed portion carried forward and allowed in subsequent years when assessable profits arise and the statutory reserve can be created.

Consequences and practical implications:

Direct effect on the parties: The ITO is to determine the development rebate admissible to the assessee for the years in question; the assessee is entitled to costs, assessed at Rs. 200.
Operational outcome: The Court directed that the rebate be determined in the first year (on the basis of cost) and that actual allowance be made in later years as assessable income permits and reserves are created to the extent profits allow, within the eight-year carry-forward limit set out in s.33(2).
Broader precedent: The opinion applies and reconciles prior authorities and Board circulars in favour of permitting determination and carry-forward of unabsorbed development rebate where initial years show losses. The Court rejected the contrary view of the Gujarat High Court in Addl. CIT v. Shri Subhlaxmi Mills to the extent it would deny the carry-forward and practical utilisation permitted by the statute. The opinion does not purport to create a novel principle beyond this statutory interpretation; its effect is to clarify administration of ss.33 and 34(3)(a) in loss years.

The Court ordered that this opinion and answer be transmitted to the Tribunal under the Registrar's signature and the seal of the Court.

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Addl. Commissioner Of Income-Tax, v. Vishnu Industrial Enterprises.

Satish Chandra, C.J:— Messrs. Vishnu Industrial Enterprises (Private) Ltd., Kanpur, the assessee, suffered losses in the assessment years 1967–68 and 1968–69. It, however, claimed development rebate in respect of plant and machinery installed in those years. The ITO repelled the claim on the view that the assessee had not debited the profit and loss account, nor created the development reserve. The Supreme Court decision in Indian Overseas Bank Ltd. v. Commissioner Of Income Tax, Madras , [1970] 77 ITR 512 applied and no development rebate was allowable.

2. On appeal, it was held that since there was no profit, development reserve could not be created, but the development rebate should have been calculated and allowed in a succeeding year in which the assessee earned profits and created the requisite reserve. The ITO was directed to determine the development rebate admissible to the assessee. The ITO appealed. The Tribunal affirmed the view of the AAC.

3. At the instance of the Commissioner, the Tribunal has referred for our opinion the following question of law:

“Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was correct in upholding the direction given by the Appellate Assistant Commissioner to the Income-tax Officer to determine the development rebate admissible to the assessee for the years 1967–68 and 1968–69, when admittedly in those years the assessee had suffered losses and had not created the statutory reserve and carry forward the same and allow it in the years in which there are profits and when reserve is created?”

4. The material provisions are ss. 33 and 34(3)(a) of the I.T Act, 1961. Section 33(1)(a) allows a deduction, subject to s. 34, in respect of the previous year in which the ship or machinery or plant was installed, a sum by way of development rebate as specified in cl. (b). Clause (b) provides rates for different kinds of ship, machinery or plant. The ship, machinery or plant should be owned by the assessee and be wholly used for purposes of business carried on by him.

5. Section 34(3)(a) lays down certain conditions subject to which the deduction referred to in s. 33 is allowed:

(a) Seventy-five per cent, of the development rebate to be actually allowed should be debited to the profit and loss account of the relevant previous year;

(b) this amount is to be credited to a reserve account;

(c) the reserve account is to be utilised by the assessee during the next eight years for purposes of the business, other than—

(i) for distribution by way of dividends or profits;

(ii) for remittance outside India as profits or for creation of any asset outside India.

6. The Explanation to this provision says:

“Explanation.— For the removal of doubts, it is hereby declared that the deduction referred to in section 33 shall not be denied by reason only that the amount debited to the profit and loss account of the relevant previous year and credited to the reserve account aforesaid exceeds the amount of the profit of such previous year (as arrived at without making the debit aforesaid) in accordance with the profit and loss account.”

7. In Indian Overseas Bank Ltd. v. Commissioner Of Income Tax, Madras , [1970] 77 ITR 512, the Supreme Court had to consider a case where the assessee had earned sufficient profits but yet had not debited the profit and loss account with the amount allowable as development rebate. It had also not created the development reserve. The Supreme Court held that creation of a reserve under s. 10(2)(vi)(b) of the Act of 1922 (which was the predecessor of ss. 33 and 34(3)(a) of of the present Act) is independent of other reserves which are to be created, for instance, under s. 17 of the Banking Companies Act. The 75 per cent, of the amount is to be debited to the profit and loss account before finalising it. The transfer of the amount to the reserve account is to be made at the time of making up of the profit and loss account. Creation of the reserve account is not an idle formality. It is meant to enable the ITO to trace it and to see to its proper utilisation for business purposes and not for prohibited purposes.

8. The Tribunal has, in our opinion, rightly observed that the Supreme Court, while deciding that case, was not at all concerned with the question as to the time or the year in which the reserve is to be created.

9. Section 32 of the Act grants depreciation allowance. The development rebate under s. 33 is allowed over and above the recoupment of the total cost of plant and machinery by way of depreciation allowance. Section 34(3)(a) permits the use of this reserve for purposes of the business of the undertaking, other than distribution by way of dividends or profits or for remittance outside India as profits, etc.

10. The allowance obviously was given to provide incentive for industrial expansion. It is allowable only once. It has no connection with depreciation allowance, which is an yearly feature. This rebate is not an expenditure allowance. It is actual money and not notional relief from taxation to be utilised for the development of the business in the next eight years.

11. There is no express provision that the reserve must be created in the year for which the rebate is to be determined. The reserve can be created only if profits are earned; else it will be forcing the assessee to create a reserve out of its capital or by borrowings, either of which events will defeat the object of enabling the company to accumulate funds to be used for its development.

12. Sub-section (2) of s. 33 clarifies the position. Under it if the total income of the assessee for the year in which machinery or plant, etc., was acquired or installed is nil or is less than the full amount of the development rebate allowable—

(1) the sum to be allowed shall be only such amount as is sufficient to reduce the said total income to nil; and

(2) The amount of the development rebate, to the extent to which it has not been allowed as aforesaid, shall be carried forward to the following assessment year, and development rebate to be allowed for the following assessment year shall be such amount as is sufficient to reduce the total income of the assessee assessable for that assessment year, to nil, and the balance of the development rebate, if any, still outstanding shall be carried forward for a total period of eight years.

13. This provision shows that the allowability of the development rebate is not confined to the first year. It can be carried forward and allowed against income accruing in succeeding seven years.

14. Sub-section (2) contemplates a case where the assessable income is nil and even then rebate is to be carried forward. There is no reason why the rebate be not carried forward in case of loss. Of course, it cannot be carried forward for more than eight years in all.

15. The allowable development rebate is to be calculated in relation to the cost. That information is available in the very first year. There is no difficulty in the ITO doing the requisite calculation and determining the allowable amount of development rebate. The adjustment is to take place as and when assessable income is available.

16. Section 34(3)(a) opens—“The deduction referred to in section 33 shall not be allowed unless……” This provision comes into play at the time of actual allowance of the rebate. The conditions precedent should be complied with at that time. Before an assessee claims the deduction, he should create a reserve by debiting the profit and loss account and crediting the reserve account with the requisite amount of money. This can be done only in the year in which profits are earned. The scheme of carrying forward unabsorbed development rebate postulated by sub-s. (2) of s. 33 can be achieved only if it is permissible to create reserve by making the requisite entries to the extent the income is able to absorb the rebate. The full reserve may not be created in a single year; depending on the available income it may take more than one year to create the reserve to the full extent of the development rebate which is allowable, and which has already been determined.

17. The proper procedure is that the amount of the development rebate ought to be determined in the first year. Its actual adjustment will be dependent on the availability of income. In the case of loss, the determination has to be done in the first year; the adjustments are to be actually made in subsequent years where profits are available.

18. The position was clarified by the Board of Direct Taxes in its Circular F. No. 10/49/65-ITA-I, dated 14th October, 1965, which, inter alia, explained the position regarding the creation of statutory reserve for allowance of development rebate, as follows (See [1976] 102 ITR (St.) 90):

“(a) In the case of certain industrial undertakings, particularly those in which there is Government participation either by way of capital, loan or guarantee, and where there are certain obligations of law or agreement about maintenance of reserve for development purposes, the development rebate reserve may be treated as included in the said reserve though not specifically created as a development rebate reserve.

(b) In a case where the total income computed before allowing the development rebate is a loss, there was no legal obligation to create any statutory reserve in that year, as no development rebate would actually be allowed in that year.

(c) Where there was no deliberate contravention of the provisions, the Income-tax Officer may condone genuine deficiencies subject to the same being made good by the assessee through creation of adequate additional reserve in the current year's books in which the assessment is framed.”

19. The Board issued Circular No. 189, dated 30th January, 1976 (See [1976] 102 ITR (St.) 91), saying in para. 5 thereof thus:

“The Board have re-examined the issues involved and are of the view that except the clarification given in part (a) of para. 1 above, which stands superseded by the aforesaid decision of the Supreme Court, the clarifications given in parts (b) and (c) of para. 1 above hold good.”

20. The reference was to the decision of the Supreme Court in Indian Overseas Bank's case, [1970] 77 ITR 512.

21. In Navnit Lal C. Javeri v. K.K Sen, [1965] 56 ITR 198 (SC) and in Ellen-man Lines Ltd. v. CIT, [1971] 82 ITR 913 (SC), it has been held by the Supreme Court that the income-tax authorities are bound by the Board's Circular and that the same are entitled to be given effect to by the courts as well. These circulars support the view that we have taken.

22. Our view finds support in the decisions of the Calcutta High Court (West Laikdihi Coal Co. Ltd. v. CIT, [1973] 87 ITR 501), Bombay High Court (Indian Oil Corporation Ltd. v. S. Rajagopalan, ITO, [1973] 92 ITR 241 and Tata Iron & Steel Co. Ltd. v. N.C Upadhyaya, [1974] 96 ITR 1), Orissa High Court (CIT v. Narula Cold Storage & Ice Factory, [1976] 104 ITR 148) and Madras High Court (Radhika Mills Ltd. v. CIT, [1969] 74 ITR 661). With respect, we are unable to agree with the contrary view taken by the Gujarat High Court (Surat Textile Mills Ltd. v. CIT, [1971] 80 ITR 1 and Addl. CIT v. Sri Subhlaxmi Mills, [1975] 100 ITR 188). It was emphasised by their Lordships of the Gujarat High Court that allowing rebate in subsequent years would mean that the user of the reserve can be prolonged to sixteen years. If available income accrues to the assessee only in the eighth year then he would be entitled to utilise the reserve during the next eight years. This would happen in an extreme case, where the assessee continues to suffer losses for seven years in succession. The legislative intent in granting the development rebate was to permit the assessee to use of part of its profits for development purposes. This could be done only after profits have been earned. If profits accrue for the first time in the eighth year, there is nothing unconscionable in the utilisation taking place in the next seven years. But s. 33(2) makes it clear that the development rebate cannot be carried forward for more than eight years after the installation of the machinery or plant.

23. By the Finance Act of 1966, the Explanation was added to s. 34(3)(a) with retrospective effect. It was clarificatory. It stated that the development rebate shall not be denied only because the amount debited to the profit and loss account and credited to the reserve account exceeds the amount of profit available.

24. Learned counsel for the department, relying on the decision of the Gujarat High Court in Addl. CIT v. Shri Subhlaxmi Mills, [1975] 100 ITR 188, contended that the legislature intended that the reserve should be created irrespective of the surplus profit being available or not.

25. In our opinion, the intention behind the enactment of the Explanation was just the contrary. Even where an assessee creates a reserve when sufficient profits are not available the rebate is not to be denied. That does not mean that the entire rebate is to be allowed. That will be contrary to the scheme of carry forward of unabsorbed rebate provided in sub-s. (2) of s. 33. The Explanation intends that this irregularity be overlooked and the rebate allowed to the extent of available profits. In other words, Parliament indicated that artificial debiting and creation of reserve was not proper. It did not contemplate an idle formality of creation of an illusory reserve. We, therefore, answer the question referred to us in the affirmative, in favour of the assessee and against the department. The assessee will be entitled to costs, which are assessed at Rs. 200.

26. Let this opinion and answer be transmitted to the Tribunal under the signature of the Registrar and the seal of the court.

Addl. Commissioner Of Income-Tax, v. Vishnu Industrial Enterprises.

Structured Summary of the Court's Opinion

Factual and Procedural Background

Legal Issues Presented

Arguments of the Parties

Assessee / Appellant (as reflected in the AAC and Tribunal findings)

Revenue / Department (as presented in the opinion)

Table of Precedents Cited

Court's Reasoning and Analysis

Holding and Implications

Addl. Commissioner Of Income-Tax, v. Vishnu Industrial Enterprises.

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