The Judgment of the Court was delivered by

Sabyasachi Mukharji, J.:— In this reference under s. 256(1) of the I.T Act, 1961, the following question has been referred to this court:

“Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the reserve for bad and doubtful debts and reserve for gratuity were to be included in the computation of capital under the provisions of the Second Schedule to the Companies (Profits) Surtax Act, 1964?”

2. The assessee is a private limited company. The relevant assessment year is 1966-67, in respect of which the corresponding previous year ended on December 31, 1965. It has been publishing a Bengali daily in the name and style of “Jugantar”. In the computation of capital for the purpose of surtax assessment under the provisions of the Companies (Prpfits) Surtax Act, 1964, the assessee-company included reserves for bad and doubtful debts and for gratuity. In his computation, according to the Second Schedule to the said Act, the ITO refused to treat the said reserves as reserves forming part of the assessee's capital base. The assessee being aggrieved, went up in appeal before the AAC. The AAC perused the balance-sheet and he found amounts of Rs. 9,08,633 and Rs. 5,47,160 as outstanding from the debtors which were respectively earmarked as good debts and doubtful debts. These figures were found to be appearing in the balance-sheet as on the first day of the accounting year and therein on the same day, a sum of Rs. 3,38,000 was figuring as reserves for bad and doubtful debts. According to the AAC, such reserves, viz., reserves for bad and doubtful debts, by the very nomenclature, would imply specific and ascertained liability and, therefore, he treated the same to be provision. Similarly, in respect of Rs. 4,24,371 as reserve for gratuity appearing on the first day of the relevant accounting year, the AAC found that the assessee had credited out of the transfer of certain amounts to the reserve account as and when an employee retired and the gratuity was payable to the said employee. It was noticed that the payment was made out of these reserves. According to the AAC, this was not contrary to the position which would imply if the employee was paid directly by charging to the profit and loss account. In these circumstances, the AAC held that the reserve for gratuity being in the nature of a provision for payments to retiring employees could not be a free reserve for inclusion in the capital base. He, accordingly, upheld the order of the ITO.

3. The assessee went up in appeal before the Tribunal. The Tribunal, after considering the relevant provisions and the relevant case law, was of the view that the assessee's contentions were right and directed the ITO to recompute the capital base and to include the two amounts in question for bad and doubtful debt reserve and the reserve for gratuity in the capital computation in order to ascertain the quantum of statutory deduction in accordance with s. 2(8) of the Surtax Act, 1964.

4. In the circumstances as aforesaid, the question indicated above has been referred to this court.

5. So far as the bad and doubtful debts are concerned, in view of the facts as appearing from the orders of the A AC and in’ view of the ratio of the decision of this court in the case of CIT v. Eyre Smelting P. Ltd., [1979] 118 ITR 857, it appears to us that the Tribunal was in error in holding that the bad and doubtful debts could form part of the reserve. The provision in the instant case from the facts found appears to have been made for an anticipated contingency and was intended to meet the anticipated diminution in the value of the assets of the assessee, resulting from unrealised debts. This contingency was known and anticipated, as appears from the facts found, at the date of the balance-sheet and the amounts set apart for the item though not determined with accuracy, was estimated. Therefore, the same could not be treated as a reserve for the purpose of computing the capital under Sch. II to the Super Profits Tax Act, 1963. This position is fortified by the form of the balance-sheet which appears in Sch. VI to the Companies Act, 1956, under the item of “Current assets and liabilities” and item 6 provides under sub-cl. (b) “other debts less provision”. So the provision for bad and doubtful debts, which is anticipated, is an anticipatory diminution in the value. In that view of the matter, following the ratio of the said decision referred to hereinbefore, the first part of the question which is directed for bad and doubtful debts must be answered by saying that the Tribunal was not justified that these amounts should be included in the computation of capital under the provisions of the relevant Schedule to the relevant Act.

6. The next part of the question centres round the controversy as to the provision for gratuity. We have set out the facts and we have noted that the payments were made out of the reserves and the provision was made to meet the liability to gratuity to the workers and, therefore, it was found that the provision was not a free reserve.

7. In the case of CIT v. Burn and Co. Ltd., [1978] 114 ITR 565 (Cal), we had to discuss this aspect rather exhaustively, though in the context of Super Profits Tax Act, 1963. There, we had reiterated that the question raised was whether in considering the expression “reserve” under the relevant rule whether it had to be understood in its ordinary sense or in the sense in which it was understood in commercial accountancy and we observed that the use of the expression “all other reserves”, in so far as the amounts credited to such other reserves had not been allowed in computing its profits for the purpose of the I.T Act in r. 1 of the Second Schedule to the Super Profits Tax Act, 1963, seemed to be the expression “reserve” as understood in the ordinary sense and not in contradistinction to a provision. Now, the Bombay. High Court in the case of Shree Ram Mills Ltd., [1977] 108 ITR 27, which we have exhaustively referred to in our aforesaid judgment at page 581 of the report, had laid down certain tests. One of the tests that the Bombay High Court had laid down, ‘viz., that it should be apparent from the surrounding circumstances that the amount so set apart was in fact a reserve to be utilised in future for a specific purpose on a specific occasion. But item (iv) of the conditions laid down stipulated that the amount so set apart should be available to the assessee for the purpose of its business. Therefore, we expressed our respectful agreement with the views of Mr. Justice Tulzapurkar expressed in the aforesaid decision; but these expressions had to be understood in the proper context. The basic test being, even from a common sense point of view, an amount should be considered to be reserve, in so far as it is available to the assessee for the purpose of its business in future and a decision to that effect had “been taken by those who were competent to take the decision on behalf of the assessee. In this case, in so far as the amount had been created for the purpose of meeting a liability which had arisen to the workers, the provision was to be allowed as deduction in the income-tax computation, even though it has not been allowed. Such deduction, either because it had not been claimed or wrongly disallowed, would not be considered as a sum available to the assessee for the purpose of its business in future.

8. Our attention was drawn to the decision of this Bench in the case of CIT v. Indian Standard Wagon Co. Ltd., [1979] 116 ITR 539, where we held in the facts and circumstances of that case that the sum of Rs. 20,60,862 shown by the assessee in its accounts as provision for “labour retiring gratuity” was a reserve so as to be eligible for inclusion in the capital computation under the Second Schedule to the Companies (Profits) Surtax Act, 1964, There in view of the facts which we emphasised namely, that gratuity was payable under certain conditions and on the assumption that the conditions were satisfied because the provisions had been made, an item which could not be ascertained with any substantial accuracy, either by following any normal method of accountancy—actuarial or otherwise, could not be considered to be a contingent liability which ‘merited exclusion from being considered as “reserve” in the context of r. 1 of the Second Schedule to the Act. In this case the amount has been ascertained with substantial accuracy and, furthermore, it has been for a specified liability. If that is the position’, then the ratio of the said observations made in the context of the facts of that case could not be applied merely on the theoretical basis that the labour retiring gratuity shown was a reserve which would be eligible for inclusion in the capital computation under the Second Schedule to the Companies (Profits) Surtax Act, 1964. Furthermore, it has to be emphasised that, at pages 543 and 544 we had made certain observations about the nature of current liability which was included under the heading “A” and the provisions are treated under the heading “B”, in Part I, Sch. VI, of the Companies Act. In our subsequent judgment we expressed the view that certain observations regarding the provisions, made in our aforesai 1 judgment, were perhaps a little too widely put in.

9. In any way, in the context of the present controversy, it is not necessary for us to go into this aspect of the matter. It appears that in Sch. VI, Parti of the Companies Act, item 12 of the Liabilities side under the heading “Current liabilities and Provisions”, is for insurance, pension and similar staff benefit schemes. Now, this is a liability which has to be shown and in the Explanation to the Second Schedule of the Companies (Profits) Surtax Act, 1964, it has been provided as follows:

“Explanation.— For the removal of doubts it is hereby declared 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) or item (6) or item (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 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule.”

10. Therefore, item 12 being an item under the heading “Current Liabilities and Provisions” in the column relating to liabilities cannot be regarded as reserve for the purpose of computation of capital of a company under the provisions of the Schedule to the Act. If that is the position, then, in our opinion, in view of the nature of the liability with which we are dealing with and which had been quantified with certain amount of certainty and provided for in the balance-sheet could not be considered to be a reserve. This point can be viewed from another angle, namely, that the provision for pension and gratuity of this nature where the obligation to discharge the liability is contingent on a very remote ground and is in the nature of accrued liability, should be allowed as deduction under s. 37 of the I.T Act in computing the income of an assessee. This view we had expressed in the case of a statutory liability created for the first time in the case of Commissioner Of Income-Tax (Central-I) v. Eastern Spinning Mills Ltd., [1980] 126 ITR 686 (Cal) and in the case of CIT v. National Insurance Co. of India, [1981] 127 ITR 54 (Cal) and this is ‘also in consonance with the observations of the Supreme Court in the case of Metal Box Company Of India Ltd. v. Workmen, [1969] 73 ITR 53; 39 Comp Cas 410, observations being at page 61 onwards of the report. If that is the position then under r. 1 (III) of the Second Schedule to the said Act, which deals with the rules for computing capital for the purpose of surtax, the question would arise, if an amount which has been allowed as deduction and which has been created as reserve in the computation of income of an assessee under the I.T Act, whether such an amount should be treated as a reserve. It was urged that the expression used is “allowed deduction in computing the income” but in this case there is no clear evidence whether this item has been claimed as allowable deduction in computing the income of the assessee and if so, what is the fate of the same. The fact that it has been created as a reserve as such, even though not as yet allowed as a deduction would not affect the fact that it has been created as a reserve and would not expressly or ex facie make it one which has not been allowed as a deduction. So the mere fact that it has been created as a reserve does not indicate whether it has been allowed as a deduction or not. Quite apart from it, if an amount which is deductible but has not been allowed as a deduction, though the money may be available with the assessee and would have to be given or taken into account in paying the tax liability, that amount of money was not a free reserve, as gratuity had to be paid out of the funds reserved and the amount could not be put to any lawful use in future for any purpose of the business to meet other liability (sic). If this is the position, then even by any common sense point of view which we had preferred to adhere to in treating the reserve in contradistinction to the commercial principle of accountancy, this amount should not be treated as a reserve. In that view of the matter we must hold that the Tribunal fell into an error on this aspect. In the premises, on both the aspects, the question is answered in the negative and in favour of the revenue. In the facts and circumstances of the case, the parties will pay and bear their own costs.

Sudhindra Mohan Guha, J.:— I agree.