G.K Mitter, J.:— The matter arises out of a reference under section 66(2) of the Indian Income-tax Act read with section 19 of the Business Profits Tax Act. The points of law involved are (1) whether an amount shown in the balance-sheet of the assessee company year after year at the same figure under the head “capital paid in surplus” represents premium realised from the issue of shares as contemplated by rule 3 of Schedule II of the Business Profits Tax Act, 1947, and (2) whether the several amounts appearing in the balance-sheets of the assessee company shown as “earned surplus” at the end of each year should be treated as reserves within the meaning of sub-rule (1) of rule 2 of Schedule II of the said Act. A further question also arises, namely, whether the “capital paid in surplus” can be treated as a “reserve” within the meaning of the Act.

2. The Business Profits Tax Act (hereinafter referred to as the Act), which came into force on April n, 1947, had for its object the imposition of a special tax on income arising from business by reason of the abnormal profits made in consequence of the war. This tax was over and above the levy under the Indian Income-tax Act, 1922. The Act, however, was not made to apply to the whole of the profits made in a business and a part of it was allowed to be left out of account in the computation of profits for its purposes. This was done by providing “abatement”, namely, a sum which bore to a sum equal to, in the case of a company like the assessee, six per cent, of its capital on the first day of any “chargeable accounting period” computed in accordance with Schedule II or one lakh of rupees whichever was greater. The capital, however, was not limited to the paid up capital but was also to include certain reserves and any premium realised by a company from the issue of any of its shares and retained in the business. The life of the Act came to an end on March 31, 1949. Under section 2(4) of the Act “chargeable accounting period” means any “accounting period” which fell wholly within the term beginning on April 1, 1946, and ending on March 31, 1949, and where any “accounting period” fell partly within and partly without the said term such part of that accounting period as fell within the term. The “accounting period” in relation to any business means any period which had been determined as the previous year for that business for the purpose of the Indian Income-tax Act, 1922. For our purposes “company” under the Act means a company as denned in the Indian Companies Act, 1913,… and includes any foreign association, whether incorporated or not, which the Central Board of Revenue may by general or special order declare to be a company for the purpose of the Act. “Taxable profits” means the amount by which the profit during a chargeable accounting period exceeds the abatement in respect of that period. “Profits” under the Act means profits as determined in accordance with Schedule I. Section 4 of the Act is the charging section under which tax is payable on the amount of the taxable profit during any chargeable accounting period calculated at a sum equal to 16 ⅔ per cent, of the taxable profits. Schedule I contains rules for the computation of profits for purposes of the Act. Schedule II contains rules for computing the capital of a company and rule 1 of the said Schedule provides that for the purpose of ascertaining the “abatement” under the Act in respect of any chargeable accounting period the capital of a company shall be computed in accordance with rules 2 to 4. So far as is relevant to this case rule 2 provides that “the capital of a company 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”. Further under rule 3 “so much of the premium realised by a company from the issue of any of its shares as is retained in the business shall be recorded as forming part of its paid up capital for the purposes of rule 2”.

3. According to the assessee the “capital paid in surplus” represents premium which was realised at the time the assessee issued its shares. Alternatively, it is contended that the excess of the value of the assets taken over the paid up capital of the company has always been treated as a reserve and has never been allowed in computing the profits of the company for the purposes of the Indian Income-tax Act and hence the same is to be taken into account for computing its capital.

4. The chargeable accounting periods with which we are concerned in this case are five, they extend from:

(i) 1-4-1946 to 30-11-1946

(2) 1-12-1946 to 31-3-1947

(3) 1-4-1947 to 31-12-1947

(4) 1-1-1948 to 31-12-1948

(5) I-I-1949 to 31-3-1949.

5. For all these accounting periods the “capital paid in surplus” remained the same. The earned surplus has varied from time to time but it has always gone on increasing and is said to represent that part of the profits of the assessee which has been set apart after the distribution of dividends.

6. The facts relating to the accounts of the company are as follows: The assessee is a non-resident company. It was incorporated in the State of Delaware in U.S.A with a capital of $10,000,000 divided into 1,00,000 shares of the par value of $ 100 each. The object of incorporation was to take over all the assets and liabilities of two existing companies, namely, Soconey Vacuum Corporation and Standard Oil Company (New Jersey) in the Far East. The net assets of these two contributing companies in the Far East stood in their books on January 1, 1934, at the following figures:

Soconey Vacuum Corporation $97715.701 Standard Oil Co. (New Jersey) $146,767,397 $ 144,483,098

7. As consideration for the transfer the said two companies were each allotted 49,995 shares in the new company, the Soconey Vacuum Corporation being allotted in addition serial bonds of the face value of $13,093,000. Five shares of the new company were allotted to each of the old companies for payment in cash. The allotment of these bonds of an amount less than the difference between the net book value of the assets contributed by the two companies was said to be due to the circumstances that the contribution of the Standard Oil Company (New Jersey) was considered to carry with it considerable intangible values (such as oil wells) not reflected in the book values. The new company, the assessee before us, after taking over the assets from the said two companies, entered in its books of account the exact value of the assets taken over and the difference between the book value of the assets and the actual purchase consideration on the basis of par value of the shares was credited in an account under the head “capital paid in surplus”. In the books of the vendor companies the transactions were recorded as follows:

Standard Oil Company (New Jersey) Share of account Standard Vacuum Oil Company 5 shares purchased for cash $ 500 49.995 shares purchased (for con-sideration other than cash) (value of new asset taken over) $ 46,767,397 Soconey Vacuum Oil Company $ 46,767,897 5 shares purchased for cash 49,995 shares purchased for con-sideration other than cash $ 500 (Value of net asset) 97,715,702 Less face value of fully paid serial bonds 13,093,000 $ 84,622,702 $ 5,84,623,202

8. Thereafter the serial bonds were redeemed and in the books of the assessee company some adjustments were made in the account styled “capital paid in surplus” and the original figure of % 121,391,098 was reduced to $117,561,317. This amount continued to appear in the balance-sheet year after year until December 31, 1945. Leaving out of account the adjustments referred to above the difference between the net value of the assets transferred and the face value of the shares together with the par value of the serial bonds allotted to Soconey Vacuum Corporation was represented by the figure $ 117,561,317.

9. Both the vendor companies disclosed in their books of account, as the cost of the respective investments in the shares of the assessee company, the value of the assets which they transferred to the assessee company. In all assessment proceedings for the purpose of depreciation, the value of the aforesaid assets was taken at cost. A summary of the consolidated world balance-sheet of the assessee as on December 31, 1945, taken from the statement of case is given below:

Consolidated Balance-Sheet at December 31, 1945.

(Relevant for the chargeable accounting period from 1-4-1946 to 30-11-1946).

Consolidated Balance-Sheet at December 31, 1945. (Relevant for the chargeable accounting period from 1-4-1946 to 30-11-1946). Assets Liabilities: Capital Stock & Surplus Current assets $ 143,376,559 Current liabilities $ 70,187,822 Govt. of India compulsory Excess Profits Tax Due to subsidiaries not consolidated $ 92,260 Deposit (Recoverable) $ 1,755,597 Deferred credits $ 161,387 Due from Soconey Vacuum Oil Co. incorporated and Standard Oil Co. (New Jersey) Reserves $ 26,122,646 Capital stock surplus $ 10,000,000 $ 50,000,000 Investments and advances $ 25,071,665 Capital surplus paid in (no change during the year) $ 117,561,317 Fixed assets $33,044,388 Earned Deferred charges $ 434,820 surplus $ 29,557,597 $ 147,118,914 $ 253,683,029 $ 253,683,029

10. It will be noted that in contrast to the system prevailing in India assets are accounted for in the left hand column and capital and liabilities on ttie right hand side. The figures under the heading “capital and surplus” with which we are concerned are the last two.

11. For the year ending on December 31, 1946, which is relevant for two chargeable accounting periods from December 1, 1946, to March 31, 1947, and April 1, 1947, to December 31, 1947, the surplus shown by the assessee included the “capitalpaid in surplus” of $117,561,317and earned surplus of $43,912,968. For the chargeable accounting period January 1, 1948, to December 31, 1948, the capital surplus paid in is the same and the earned surplus is $56,774,805, that for the year ended December 31, 1948, shows the earned surplus as $73,766,592.

12. So far as “earned surplus” is concerned the statement of case shows that the figure stood at $29,557,597 for the chargeable accounting period ending November 30, 1946, at $43,912,968 for periods ending March 31, 1947, and December 31, 1947, at $56,774,805 for the period ending December 31, 1948, and at $73,766,592 for the period ending December 31, 1949. The finding of the Appellate Tribunal is that the assessee company was retaining the aforesaid sums out of its current profits for the purpose of its business expansion. The Tribunal further found the net profits, the appropriations and the earned surplus (in dollars)-as follows:

Year Previous balance of earned surplus Net profit for the year Appropria-tions Balance of earned surplus at the end of the year Assets at cost 1945 16,299,765 13,257,814 — 29,567.597 76,541,674 1946 29,557.597 24,355,370 10,000,000 43,912,968 82,534.231 1947 43,912,968 22,861,837 10,000,000 56,774,805 110,767,579 1948 56,774,805 36,991,787 20,000,000 73,766,592 196,720,177 1949 73,766,592 38,882,589 20,000,000 92,649,181 207,450,227

13. The Tribunal recorded that the assessee withheld very substantial part of its yearly profits for the purpose of re-investing into its business and although such withholding of profits had not been specifically termed as reserves in the account of the company there was no doubt that the figures represented reserves which should be added to the paid-up capital under Rule 2(1) of Schedule II to the Act. The Tribunal negatived the contention of the revenue that “earned surplus” merely represented the balance of the profit and loss account. The finding of the Tribunal is fortified by a comparison of the value of the fixed assets which went on rising from $69,000,000 in 1944 to $276,000,000 in 1952.

14. The Income-tax Officer relied on the judgment of the Bombay High Court in Century Spinning & Manufacturing Co.'s case [1951] 20 I.T.R 260., to negative the contention of the assessee that the “earned surplus” constituted a reserve. Before the Appellate Assistant Commissioner the assessee pointed out that in the American system of accounting the appropriations for the year are to be made during the year and even the dividend which is declared just after the close of the year is passed through the relevant earned surplus account which is termed as profit and loss account in India. The Appellate Assistant Commissioner recorded that surplus in each year had been re-invested in the business. Before him it was argued that the practice of transferring profits to general reserve was not prevalent in America and consequently the “earned surplus” amounting to $29,557,597 at the end of the year 1945 should be treated as general reserve and taken into account in computing the capital of the company for the purpose of the Act. The Appellate Assistant Commissioner agreed that the accumulated balance in the profit and loss account had actually been invested in the business and there was no regulation in the American Income-tax Act for setting apart any part of the profit in general reserves but he went on to add that as the assessment was under the Indian Income-tax Act the assessee must set apart a particular amount out of the profit to reserve in order to get the same taken into account for the purpose of computation of capital.

15. The assessee claimed that the amount of $117,561,317 disclosed under the head “capital surplus paid in” was premium realised on the issue of the shares to the transferor companies and as such within the meaning of the word “premium” as used in rule 3 of Schedule II to the Act. Alternatively, it was claimed that it formed a part of the reserves as envisaged in rule 2 of Schedule II and hence to be considered in computing the average capital. Further, the “earned surplus” disclosed in the various accounting years should be treated as reserves within the meaning of rule 2 of Schedule II of the Act and also to be included in the computation of the average capital.

16. Both the Income-tax Officer and the Appellate Assistant Commissioner negatived the claim of the assessee on all the heads because the company, although asked to produce a copy of the original agreement between it and the two vendor companies at the time of incorporation, did not produce the same on the ground that there was no such agreement. Further the assessee did not produce the relevant resolution of the board of directors on the ground that there were certain confidential reasons which stood in the way of doing so. The Income-tax Officer held that so far as “capital surplus paid in” was concerned,. it could only be regarded as premium on shares if at the time of their issue it had been stated that the shares were being issued at a premium and shares could not be treated as having been issued at a premium merely because the transaction leading to their issue actually resulted in a surplus to the company. Both the Income-tax Officer and the Appellate Assistant Commissioner were of the view that this amount could not be included as “reserves” as it had not been created out of the profits of the company within the meaning of rule 2 of Schedule II to the Act. They relied on the judgment of Chagla C.J in the case of Century Spinning Mills. They further negatived the claim of the assessee with regard to the “earned surplus” on the basis of the said decision of the Bombay High Court, namely, that they had not been set apart or allocated as reserves.

17. As already noted, the Tribunal however took a different view and the questions formulated by this court on the application of the Commissioner of Income-tax are as follows:

“(1) Whether, on the facts found, the Tribunal was right in holding that the sum of $117,000,000 appearing in the balance-sheet of the assessee company under the head ‘capital paid in surplus’ and constituting the excess of the book value of the assets over the face value of the shares represented premium realised from the issue of the shares as contemplated by rule 3 of Schedule II of the Business Profits Tax Act, 1947?”

“(2) Whether on the facts and in the circumstances of the case the Tribunal was right in holding that the fact that the amount in question had been built up out of capital and not out of taxed profits would not prevent it from being reserve as contemplated by sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act?”

“(3) Whether on the facts and in the circumstances of the case the Tribunal was right in holding that the sum of $29,000,000 odd, $ 43,000,000 odd, $ 56,000,000 odd and $ 73,000,000 odd, for the respective years appearing in the balance-sheets of the assessee as ‘earned surplus’ could be treated as a reserve within the meaning of sub-rule (1) of rule 2 of Schedule II of the Business Profits Tax Act?”

18. Neither of the words “reserve” or “premium” has been defined in the Act and therefore the plain and ordinary meaning applicable to these words have to be taken into account for the purpose of finding out whether “capital surplus paid in” can be described either as a premium on issue of shares or as a reserve and whether “earned surplus” can be described as a reserve for the purpose of the Act.

19. According to the Indian Companies Act, which was in force from 1946 to 1949, it was obligatory on every company to keep proper books of account in terms of section 130 of the Companies Act of 1913. The directors of every company had to lay once at least in every calendar year before the company in general meeting a balance-sheet and profit and loss account. Such balance-sheet and profit and loss account had to be audited by the auditors of the company as provided and the report of the auditors had to be attached thereto, such report being available for inspection by any member of the company. Under section 131A the directors had to make out and attach to every balance-sheet a report with respect to the state of the company's affairs, the amount, if any, which they recommended to be paid by way of dividend and the amount, if any, which they proposed to carry to the reserve fund or to the general reserve or reserve account shown specifically on the balance-sheet. Under section 132 the balance-sheet was to contain a summary of the property and assets and of the capital and liabilities of the company in accordance with the requirements indicated by the heads contained in the Form marked “F” in the Third Schedule. Form “F” contains a head “reserve” under the heading “capital and liabilities”.

20. Regulation 99 of Table A empowered the directors to set aside out of the profits of the company such sums as they might think proper as reserve or reserves before recommending any dividend for the purpose of meeting contingencies or for equalising dividends or for any other purpose to which the profit of the company might be properly applied.

21. “Premium”, according to the dictionary, means a reward, a bonus, a bounty or something beyond the amount claimable. It was pointed out as early as in 1892 in Ooregum Gold Mining Co. of India Ltd. v. Roper by Lord Watson that “a company is free to contract with an applicant for its shares; and when he pays in cash the nominal amount of the shares allotted to him, the company may at once return the money in satisfaction of its legal indebtedness for goods supplied or services rendered by him. That circuitous process is not essential… It has been ruled that, so long as the company honestly regards the consideration given as fairly representing the nominal value of the shares in cash, its estimate ought not to be critically examined.” There is consequently no legal bar to a company at its inception issuing shares to persons for consideration other than cash. If the monetary value of such consideration exceeds the face value of the shares I do not see any reason why it cannot be said that the company is issuing shares at a premium. Ordinarily no doubt a transferor of the assets would insist on getting the full value thereof but there may be considerations influencing him in taking shares in a new company in exchange for assets which are worth more in the hope that the profits earned will recompense him for the sacrifice made. The more so, if he is going to control the company. In the case of the assessee company the two vendor companies parted with all their assets in the Far East to take shares half and half. Consequently, the transferor companies did not really stand to lose anything. If, therefore, the transferor companies have taken shares in lieu of assets which far exceeded the par value of the shares, the assessee company must be said to have been fortunate enough to have issued its shares at a premium. Further, as the amount of $ 117,561,317 has all along been shown as the “capital surplus paid in” it can be said that the company has treated the said amount as a reserve without using the said word. This is the view which was taken by the Income-tax Appellate Tribunal.

22. As against this, it has been contended that the shares can be said to have been issued at a premium only when they have been issued for cash in excess of their face value and reliance was placed on the case of Drown v. Gaumont-British Picture Corporation Ltd. in this connection. In this case the company had been issuing shares from time to time at a premium in cash and such premium was from time to time carried to reserve. On March 31, 1936, there existed a balance carried to reserve of £ 500,000 built up partly from premiums on the issue of shares and the question before the court was, whether there was anything in company law to prevent the company from paying dividends out of assets representing premium received on the issue of shares. Reference was made to the observations of Clauson J. at page 403: “The premium from its very nature is not part of the capital paid up on the shares; it is the surplus of the sum received in respect of the share over the amount required to pay up the share to the extent to which it is treated by the company as paid up” and it was argued that such surplus could only be in cash. In that case there was no question as to whether premium could take any other shape but from this it did not follow that the word “premium” could not be applied to a case where shares were issued for consideration other than cash.

23. Until 1948, there was no statutory provision in England with regard to issue of shares at a premium. Section 56 of the English Companies Act, 1948, provided that, “where a company issues shares at a premium whether for cash or otherwise a sum equal to the aggregate amount or value of the premiums on those shares shall be transferred to an account to be called the ‘share premium account’ and the provisions of the Act relating to the reduction of the share capital of the company shall, except as provided in this section, apply as if the share premium account were paid up share capital of the company”. Similar provision was introduced in India for the first time by section 78 of the Companies Act of 1956.

24. In Head (Henry) & Co. Ltd. v. Rofiner Holdings Ltd. Harman J. remarked with regard to the issue of shares at a premium that “everybody, I suppose, who hears those words thinks of a company which, being in a strong trading position, wants further capital and puts forward its shares for the subscription of the public at such a price as the market in those shares justifies, whatever it may be, 30s. or £ 4 above the nominal value of a share which it acquires as a result of that transaction is no doubt a premium. That is what is ordinarily meant by the issue of shares at a premium;” His Lordship went on to consider what the word “otherwise” could refer to and said “apparently, if the shares are issued for a consideration other than cash and the value of the assets acquired is more than the nominal value of the shares issued, you have issued shares at a premium”.

25. Counsel for the revenue relied on the observations of the learned judge “that it was with a sense, of shock at first that one heard the transaction referred to as an issue of shares at a premium”. It was argued that this went to show that shares could never be said to have been issued at a premium in England before 1948 and in India before 1956, when there was no cash passing in the transaction. It would appear that the legislatures, both Indian and English, thought that shares issued for consideration other than cash could also be said to have been issued at a premium in a proper case and I can see nothing in the use of the word “premium” as used by the legislature in India in any Act enacted before 1956 to denote that it must be restricted to a transaction in cash. In this respect the Tribunal seems to have come to the right conclusion and the figure of $ 117,561,317 must be held to be a premium received by the assessee company when issuing shares in 1934.

26. The dictionary meaning of the word “reserve” includes: (a) something kept for future use or stored up for some time or occasion; (b) something kept back or held over to a later time in view and (c) something preserved. Apart from the provisions of taxing statutes a company is free to deal with its profits in such ways as it pleases and it may create any number of reserves. Thus, for instance, the reserves may take any of the following character:

(1) Capital reserve including reserve for redemption of redeemable preference shares.

(2) Reserve for redemption of debentures.

(3) Reserve for replacement of plant and machinery.

(4) Reserve for buying new plant to be added to the existing ones.

(5) Reserve for bad and doubtful debts.

(6) General Reserve.

27. Other reserves may be created by companies for special purposes. Excepting the last, the above reserves are all earmarked for one or other purpose. In view, however, of the provisions of the Indian Income-tax Act, 1922, a company is not free to deal with the entire profits after meeting its expenses in any manner it likes but has to pay tax after deductions allowed under section 10 of the Act are taken into account. Section 10(2)(vi) of the Income-tax Act allows a company to set apart a portion of its profits to meet depreciation on buildings, machinery, plant or furniture, and any reserve which a company may wish to make in this respect will be taken into account in computing the profits for the purposes of the Indian Income-tax Act. Section 10(2)(xi) of the Indian Income-tax Act allows deductions in respect of bad and doubtful debts. Consequently, reserves for these purposes created by the company will be allowed in computing its profits for the purpose of the Indian Income-tax Act, 1922. These reserves, to the extent to which they have been allowed, will not be added to the capital of the company for the computation of capital. Rule 2(1) of Schedule II to the Business Profits Tax Act, 1947, in my view, only excludes reserves which have been created out of allowances permissible under section 10 of the Indian Income-tax Act, 1922. If the company has any reserves created before the commencement of the Act of 1947 which were not deductions under section 10(2) of the Indian Income-tax Act the same can be legitimately added to the paid up share capital of a company to find out the abatement permissible under section 10(2) of the Act. Again any reserves which have been created out of taxed profits can be similarly added.

28. Reliance was placed on certain observations of Chagla C.J in Commissioner of Income-tax v. Century Spinning and Manufacturing Co. Ltd. for the proposition that reserves which had not been created out of taxed profits could not be considered for computation of capital under Schedule II to the Act. The learned Chief Justice said that “in order to determine the capital of the company for the purpose of this Act you have got to take the paid-up share capital of the company, then you have to add to it the reserves and you have to add only those reserves, which have been subjected to taxation”. With great respect to his Lordship I cannot see why reserves must necessarily have been subjected to taxation before they can be added to the paid up share capital of the company to determine the abatement permissible under the Act. If for instance a company had certain reserves created before the Indian Income-tax Act, 1922, came into force, I see no reason why the company cannot claim to add the same to its paid up capital for finding out the abatement allowable. Rule 2(1) of the Act only shuts out reserves which have not been allowed in computing the profits of the company for the purpose of the Indian Income-tax Act, 1922. If the company had any reserves like a “capital reserve” or reserve for redemption of debentures or preference shares before the Act of 1922 came into force, the company can lawfully claim the same to be taken into account for the determination of the abatement. After the Indian Income-tax Act of 1922 came into force, it would be open to the company to create reserves out of allowable deductions under section 10(2) of the Indian Income-tax Act as well as out of net profits after payment of the tax. Rule 2(1) would exclude the first kind of reserves but not those of the second kind.

29. Counsel for the revenue drew my attention to the observations of the Supreme Court in Commissioner of Income-tax v. Century Spinning and Manufacturing Co. Ltd. reading that “two essential characteristics must be present before the assessee can avail himself of the benefit of the rule, namely, that the amount should not have been allowed in computing the profits of the company for the purposes of the Income-tax Act and that it should be a reserve as contemplated by the rule. That it has not been so allowed is not denied and therefore the only question is whether it can be treated as a reserve within the meaning of the rule.” It was argued that this dictum showed that the Supreme Court was accepting the view of Chagla C.J that a reserve could only be created out of profits subjected to taxation. I may say that the point as to subjection to taxation did not arise either in the Supreme Court or before the Bombay High Court and I cannot, therefore, hold that the Supreme Court meant to lay down the proposition that reserves could only be created out of taxed profits.

30. On behalf of the revenue it was further argued that the judgment of the Supreme Court in Century Spinning and Manufacturing Co.'s case showed that unless a portion of the profits were set apart for any special purpose by the company the same could not constitute reserves and that there must be a clear indication to show that a particular amount was a reserve of a particular kind. In my view, the Supreme Court never meant to say that unless the directors made a recommendation accepted later on by the shareholders to describe a particular sum as a reserve it could not be taken as such for the purposes of the Business Profits Tax Act. The facts in Century Spinning and Manufacturing Co.'s case were that after making provision for depreciation and taxation a balance of Rs. 5,08,637 was carried to the balance-sheet. The assessee in that case went by the calendar year and the chargeable accounting period was April 1, 1946, to December 31, 1946, in respect of profits ending with December 31, 1945. On February 28, 1946, the directors recommended that Rs. 4,92,426 out of the sum of Rs. 5,08,637 should be distributed as dividend and the balance of Rs. 16,211 should be carried forward to the next year's account. This recommendation was accepted by the shareholders in their meeting on April 3, 1946. On these facts the Supreme Court held that the directors had clearly earmarked the bulk of the sum of Rs. 5,08,637 for distribution as dividend and did not choose to make it a reserve. Nor did the company in its meeting on April 3, 1946, decide that it was a reserve. It remained on April 1, 1946, as a mass of undistributed profits which were available for distribution and not earmarked as a reserve. On January 1, 1946, the amount was simply brought from the profit and loss account to the next year and nobcdy with any authority on that date made or declared the amount to be a reserve.

31. In the case of First National City Bank v. Commissioner of Income-tax the question was whether “undivided profits” shown in the balance-sheet of the bank could be treated as reserves. “Undivided profits” of the bank, which was incorporated in the United States of America, were found by the Supreme Court to be equivalent to the unallocated amount carried forward at the end of the year of account in the balance of profit and loss account as known in India. This “undivided profits” had been ignored by the Income-tax Tribunal of Bombay for., the purpose of determination of abatement under the Business Profits Tax Act. The Supreme Court held that the Tribunal had gone wrong in this finding and on the basis of a letter from the Deputy Controller of Currency, Washington, came to the conclusion that the creation and maintenance of the item known as ‘undivided profits’ is a requirement of the Treasury Rules which are made under the statute and, therefore, it cannot be said that the amount of ‘undivided profits’ in the balance-sheet was not allocated as a result of either a resolution of the directors accepted by the shareholders or on account of the requirements of the law”. The Supreme Court went on to note the difference between the system of accounting of banking companies in India and the United States and observed that” in the system of accounting in the U.S.A each year's account is self-contained and nothing is carried forward. If after allocating the profits to diverse heads mentioned above any balance remains, it is credited to the ‘undivided profits’ which become part of the capital fund. If in any year as a result of the allocation there is a loss the accumulated undivided profits of the previous years are drawn upon and if that fund is exhausted the banking company draws upon the surplus. In its very nature the undivided profits are accumulation of amounts of residue on hand at the end of year of successive periods of accounting and these amounts are by the prevailing accounting practice and the Treasury directions regarded as a part of the capital fund of the banking company.”

32. The judgment of the Supreme Court in the case of First National City Bank clearly shows that it is not necessary for the shareholders to declare a certain sum as a reserve and according to the method of accounting adopted by a company a sum may be a reserve although not specifically described as such. The Supreme Court accepted the explanation contained in the copy of the letter of the Deputy Controller of Currency, Washington, that undivided profits of a bank were to be treated as a part of its capital funds. The Supreme Court further noted that in the system of accounting in the U.S.A each year's account was self contained and nothing was carried forward.

33. The “earned surplus” of the assessee before us was not wholly a mass of undivided profits but as found by the Appellate Assistant Commissioner and the Tribunal it represented profits which were put into the business for the purpose of expansion after the declaration of dividends when dividends were decided to be declared.

34. Before the Appellate Assistant Commissioner it was argued on behalf of the assessee that the practice of transferring any part of the profits to a general reserve did not prevail in America but in view of the fact that surplus after distribution of dividends was being carried forward and used in business expansion it should be treated as general reserve. The Appellate Assistant Commissioner accepted this argument and noted that “the accumulated balance in the profit and loss account has actually been invested in the business and there is no regulation in the American Income-tax Act for setting apart any part of the profits in general reserve”. He, however, went on to add “but it is an assessment under the Indian Act which provides that in order to get the benefit of capital the appellant must set apart the amount out of the profits to reserves,” and he could not therefore accept the claim of-the assessee. The Tribunal examined the table showing the earned surplus, the net profits, the appropriations made within the year, the “earnings re-invested and the fixed assets placed before the Appellate Assistant Commissioner and noted at page 95 of the paper-book (reproduced earlier in this judgment) and came to the finding “that out of the profits of the two years ending November 30, 1945, no appropriations were made. This means that the total sum of those two years'. profits were retained in the business and were to that extent treated as reserves.” The Tribunal went on to examine the figures for subse-quent years up to December 31, 1948, and found that the appellant company had withheld very substantial parts of its yearly profits for the purpose of re-investing in the business and there was no doubt that the withholding of profits constituted reserves of the assessee. Therefore, it could legitimately be said that they were used in the business in the same way as the capital of the company and were set apart for a specific purpose, namely, business expansion. The terminology used does not matter and what we have got to ascertain is the substance of the transaction. The Appellate Assistant Commissioner seems to have negatived the claim of the assessee on a technical ground which was, in my opinion, rightly rejected by the Tribunal.

35. Before us it was argued that there was no evidence before the Tribunal about the practice prevalent in America with regard to the setting apart of a part of the profits of a company by way of reserves as there was in the case of First National City Bank of New York. It was argued that the matter being one relating to American Law it should have been proved as a fact by expert evidence called for the purpose. It might have been open to the Appellate Assistant Commissioner and the Tribunal to reject the claim of the assessee on the ground that they were not satisfied with what was stated to be the American practice in the matter of constitution of reserves; but not only was no such course adopted, the Appellate Assistant Commissioner seems to have been aware of the American practice of not referring to any part of the profits as a general reserve. The only difficulty felt by the Appellate Assistant Commissioner was that the nomenclature used by the Indian Act had not been adopted. This, however, did not seem to trouble the Appellate Tribunal which recorded a clear finding that the “earned surplus” had not only been retained in the business but had actually gone into the expansion of the fixed assets. The objection of the revenue on this ground cannot be entertained at this stage in view of the finding recorded.

36. I find no difficulty in holding that the “capital paid in surplus”, which remained constant from 1934 to 1945, can also be treated as a reserve in the light of the above. The accounts of the company clearly show that it was a surplus which came in as a result of the issue of shares in 1934. It remained undisturbed for eleven years and has figured in the accounts in the same way as its paid up capital. It really partakes of the nature of a reserve. Moreover, it has never been allowed in the computation of the profits of the assessee under the Indian Income-tax Act, 1922, and, therefore, it fulfils the test laid down in Rule 2(1) of Schedule II to the Act.

37. The questions referred to this court must therefore be answered as follows:

Question 1 in the affirmative.

Question 2 in the affirmative.

Question 3 in the affirmative.

38. The assessee will have the costs of this reference.

39. Certified for two counsel.

Ray, J.:— I agree.

41. Questions answered in the affirmative.