Addl. Commissioner Of Income-Tax, Mysore v. Bharat Fritz Werner (P.) Ltd.

Venkataramaiah, J.:— The question of law referred to this court under s. 18 of the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as “the Act”), read with s. 256(1) of the I.T Act, 1961, in T.R.C No. 41 of 1974, read as follows:

“Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the amount of Rs. 1,50,000 representing the ‘preference share capital redemption reserve’ as at the beginning of the relevant accounting period should be included as part of the capital base under the Second Schedule to the Companies (Profits) Surtax Act, 1964?”

2. The question referred in T.R.C No. 42 of 1974 is practically the same except that the sum representing preference share capital redemption reserve is shown as Rs. 6,00,000, instead of Rs. 1,50,000. T.R.C No. 41 of 1974 relates to the assessment year 1966-67, corresponding to the accounting year ending July, 31, 1965, and T.R.C No. 42 of 1974 relates to the assessment year 1967-68, corresponding to the accounting year ending July 31, 1966. The assessee, in these two cases, is M/s. Bharat Fritz Werner (P.) Ltd., Bangalore. It had earlier issued redeemable cumulative preference shares of the total value of Rs. 6,00,000 which were redeemable oh December 31, 1970, or earlier at the option of the assessee.

3. In the accounting year ending July 31, 1964, the company transferred a sum of Rs. 1,50,000 from the profit and loss appropriation account to the preference share capital redemption reserve account. During the accounting year ending July 31, 1965, the assessee similarly transferred a sum of Rs. 4,50,000 to the preference share capital redemption reserve account. At the beginning of the accounting period relevant to the assessment year 1966-67, a sum of Rs. 1,50,000 was therefore available with the assessee as preference share capital redemption reserve and at the commencement of the accounting year relevant to the assessment year 1967-68, a sum of Rs. 6,00,000 was available as preference share capital redemption reserve. In the course of the assessment proceedings under the Act for the assessment year 1966-67, the assessee, therefore, claimed, that a sum of Rs. 1,50,000 should be included in, the capital base of the assessee for the purpose of determining the statutory deduction under the Act. During the assessment year 1967-68, it claimed that a sum of Rs. 6,00,000 should be taken into consideration while determining the capital base. The ITO rejected the claim made by the assessee on the ground that the appropriation of the amounts in question as reserves had’ been made by the company at the meetings held subsequent to the first day of the relevant accounting year. The assessee questioned the correctness of the orders of the ITO before the AAC of Income-tax. The appeals were allowed and the orders of the ITO disallowing the claim made by the assessee were reversed in view of the decision of the Supreme Court in CIT v. Mysore Electrical Industries Ltd., [1971] 80 ITR 566, in which the Supreme Court, “while affirming the view taken by this court, observed” that any appropriation for reserve approved at a meeting held subsequent to the commencement of the accounting year should be deemed to relate back to the date of the commencement of the accounting year and had to be treated as effective from that date. Aggrieved by the orders passed by the AAC of Income-tax, the department filed appeals before the Tribunal. Before the Tribunal, it was urged on behalf of the department that the assessee was not entitled to claim the inclusion of the sums of Rs. 1,50,000 and Rs. 6,00,000 referred to above in the capital base of the assessee during the respective years of assessment on the ground that the sums were provisions and not reserves. In support of its contention, the department relied upon els. (a) and (b) of sub-r. (1) of r. 7 of Sch. VI to the Companies Act which defined the expres sions, “provision”, “reserve” and “capital reserve” and contended that what was includible under cl. (iii) of r. 1 of the Second Schedule to the Act while determining the capital base of the company, was only a reserve and not a provision which was intended to meet a known liability. It was urged that it was known preference share capital had to be redeemed and the amount set apart for that purpose was only a provision and-not a reserve. The Tribunal rejected the contention urged on behalf of the department and dismissed the appeals filed, by it. Thereafter, at the instance of the department, the Tribunal referred the above two questions of law for the opinion of this court.

4. Under s. 4 of the Act which is the charging section, surtax is levied on every company for every assessment year commencing on, and from the 1st day of April, 1964, in respect of so much of its chargeable profits of the previous year or years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third Schedule to the Act. The expression “chargeable profits” is defined in s. 2(5) of the Act as the total income of an assessee computed under the I.T Act, 1961, for any previous year or years, as the case may be, and adjusted in accordance with the pro visions of the First Schedule. The expression “statutpry deduction” is defined in s. 2(8) as an amount equal to ten per cent, of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of two hundred thousand rupees, whichever is greater. From the foregoing, it is clear that the liability of the assessee to pay surtax will get reduced if its capital base is larger. Rule 1 of the Second Schedule to the Act sets out what the constituent elements of the capital base of a company for the purpose of levy of surtax are. Clause (ii) of r. 1 of the Second’ Schedule to the Act provides that certain kinds of reserves created under the provisions of the I.T Act shall be included in the capital. Clause (iii) which is material for the purpose of this case reads as follows:

“Its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the com-’ pany for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961).”

5. The expression “reserve” has not been defined in the Act. We have, therefore, to proceed on the basis that the said expression carries the same meaning which it has in ordinary common parlance, and as understood in company law and this view is reinforced by the Explanation to r, 1 of the Second Schedule to the Act. The reserve in question is the one created by the assessee as provided by s. 80 of the Companies Act in order to meet its liability to repay the capital covered by the redeemable preference share. Part I of Sch. VI of the Companies Act gives the form of tke balance-sheet which a company governed by that Act should prepare annually. In that form, capital redemption reserve is shown as item (2) under the head “Reserves and Surplus”. Any reserve that is created under s. 80 of the Companies Act, is called capital redemption reserve. In the instant cases, however, the assessee has called the reserve in question as the preference share capital redemption reserve. Even though the nomenclature of the reserve may be slightly different from what is mentioned in s. 80 of the Companies Act, the said reserve is in fact the capital redemption reserve referred to therein and referred to in item (2) under the head “Reserves and Surplus” in Part I-of Sch. VI of the Companies Act. In the Explanation to r. 1 of the Second Schedule to the Act it is specifically provided that any amount standing to the credit of any account in the books of a company as on the first day-of the previous year relevant to the assessment year which is of the nature of item (5), (6) or (7) under the heading “Reserves and Surplus” or of any item under the heading “Current liabilities and provisions” in the column relating to “Liabilities” in the “Form of Balance-sheet” given in Part I of Sch. VI to the Companies Act, 1956, shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of that Schedule. It follows that other reserves under the heading “Reserves and Surplus” would have to be treated as reserves for the purpose of r. 1 of the Second Schedule to the Act. Such a reserve cannot be considered as a provision as contended by the department. The Tribunal was, therefore, right in including the sum of Rs. 1,50,000 and the sum of Rs. 6,00,000 in the capital base during the relevant assessment years for purposes of determining the quantum of statutory deduction to which the assessee was entitled during the respective years.

6. In the result, we answer the question referred to us in each of the above cases in the affirmative and in favour of the assessee.

7. The department shall pay the costs of the assessee. Advocate's fee, Rs. 250 ‘(one set).