Commissioner Of Income-Tax, West Bengal-Iv, Calcutta v. Placid Limited.

Dipak Kumar Sen, J.:— M/s. Placid Limited was assessed to the Companies (Profits) Surtax Act, 1964 (hereafter referred to as “the said Act”) in the assessment year 1975–76. The assessee had included in its capital a sum of Rs. 4,41,900 shown in its balance-sheet as its capital redemption reserve. The ITO excluded this amount in the computation of capital on the ground that it was in the nature of a provision. This exclusion resulted in diminution of the standard deduction calculated on a fixed percentage of capital and a consequent increase in the chargeable profit.

2. On an appeal from the said assessment, the AAC found that a capital redemption reserve was normally created to meet an existing liability, viz., redemption of debentures, and that it was not possible to ascertain whether the amount in dispute was maintained only as a reserve. He held that the said reserve was created obviously for the redemption of debentures and confirmed the assessment. On a further appeal before the Income-tax Appellate Tribunal, the assessee contended that in the parlance of accountancy as also in law, capital redemption reserve was a part of the reserves of a company. Relying on the Explanation to rule 1 of the Second Schedule to the said Act and the form of the balance-sheet in Schedule VI of the Companies Act, 1956, where the item was specifically shown in the column for reserves, the assessee contended that the same should be treated as a reserve. The Tribunal accepted the contentions of the assessee.

3. An additional ground was raised by the assessee before the Tribunal in respect of Rs. 7,45,000 shown in the balance-sheet of the assessee as a provision for taxation. It was contended that the same should also be treated as a reserve and in the alternative should be treated as a fund within the meaning of sub-rule (ii) of rule 2 in the Second Schedule to the said Act.

4. The Tribunal allowed the assessee to raise the additional ground and following Duncan Brothers and Co. Ltd. v. CIT, [1978] 111 ITR 885 (Cal), held that the same should be treated as a fund as claimed. The ITO was directed to recompute the capital of the assessee on the basis of the aforesaid.

5. In this reference under s. 256(1) of the I.T Act, 1961, as applied to the Companies (Profits) Surtax Act, 1964, at the instance of the Revenue, the following questions have been referred by the Tribunal as questions of law arising out of the order:

“1. Whether, on the facts and in the circumstances of the case, the capital redemption reserve is a reserve within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, so as to be included as capital employed?’

2. Whether, on the facts and in the circumstances of the case, provision for taxation constituted a fund within the meaning of sub-rule (ii) of rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964?”

6. Question No. 2 appears to be settled by two decisions of this court, viz., Duncan Brothers and Co. Ltd. v. CIT, [1978] 111 ITR 885 and Duncan Brothers & Co. Ltd. v. CIT, [1981] 128 ITR 302. Following the said decisions, we answer the question in the affirmative and in favour of the assessee.

7. On question No. 1, learned advocate for the Revenue contended before us that a capital redemption reserve was in effect a provision inasmuch as the amount set apart was intended to meet a known liability, i.e, the redemption of redeemable preference shares.

8. Learned advocate for the assessee contended, on the other hand, that the law was settled that a reserve in the nature of a capital redemption reserve could never be treated as a provision. He drew our attention to s. 80 of the Companies Act, 1956, and cited the following decisions in support of his contentions:

(a) Hindustan Gas & Industries Ltd. v. CIT, [1979] 117 ITR 549 (Cal). In this case, the question referred to this court was whether the legal charges incurred for the issue of a prospectus offering redeemable preference shares to the public and underwriting commission and brokerage paid for such issue were expenditure of a capital nature.

It was held that there was a fundamental difference between capital made available to a company by issue of shares and money obtained by a company under a debenture loan and that the expenditure incurred in issuing redeemable preference shares would be capital expenditure.

(b) Addl. CIT v. Bharat Fritz Werner (P.) Ltd., [1979] 118 ITR 25. Here, a Division Bench of the Karnataka High Court held that a reserve created and named as the preference share capital redemption reserve was a capital redemption reserve as referred to in item 2 of Part 1 of Schedule VI to the Companies Act, 1956, and should be included in the capital as the item fell under the heading “Reserve” in the said Schedule.

(c) Vazir Sultan Tobacco Co. Ltd. v. CIT, [1981] 132 ITR 559 (SC). In this case, construing the concepts, “reserve” and “provision”, in the context of the said Act, the Supreme Court observed as follows (p. 568):

“According to the dictionaries (both Oxford and Webster), the applicable primary meaning of the word ‘reserve’ is: ‘to keep for future use or enjoyment; to set apart for some purpose or end in view; to keep in store for future or special use: ‘to keep in reserve’, while ‘provision’ according to Webster means: ‘something provided for future’. In other words, according to the dictionary meanings, both the words are more or less-synonymous and connote the same idea. Since the rules for computation of capital contained in the Second Schedule to the Act proceed on the basis of the formula of capital plus reserves—a formula well known in commercial accountancy, it becomes essential to know the exact connotation of the two concepts ‘reserve’ and ‘provision’ and the distinction between the two as known in commercial accountancy. Besides, though the expression ‘reserve’ is not defined in the Act, it cannot be forgotten that it occurs in a taxing statute which is applicable to companies only and to no other assessable entities and as such the expression will have to be understood in its ordinary popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to these two words in the provisions of the Companies Act, 1956, dealing with preparation of balance-sheet and profit and loss account would govern their construction for the purposes of the two taxing enactments.”

9. The Supreme Court thereafter considered Parts I and II of Schedule VI of the Companies Act and the form of balance-sheet as prescribed therein and observed further as follows (p. 570):

“……though the term ‘provision’ is defined positively by specifying what it means, the definition of ‘reserve’ is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term ‘reserve’. In other words the effect of reading the two definitions together is that if any retention or appropriation of a sum falls within the definition of ‘provision’ it can never be a reserve but it does not follow that if the retention or appropriation is not a provision it is automatically a reserve and the question will have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation has been made because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term ‘reserve’ may have to be availed of But it is clear beyond doubt that if any retention or appropriation of a sum is not a provision, that is to say, if it is not designated to meet depreciation, renewals or diminution in value of assets or any known liability, the same is not necessarily a reserve………….(p. 579). The question whether the concerned amounts in fact constituted ‘reserves’, or not will have to be decided, by having regard to the true nature and character of the sums so appropriated depending on the surrounding circumstances particularly the intention with which and the purpose for which such appropriations had been made.”

10. The Supreme Court also considered one of its earlier decisions in CIT v. Century Spinning & Manufacturing Co. Ltd., [1953] 24 ITR 499 and set out with approval the ratio therein as follows (p. 581 of 132 ITR):

“(a) a mass of undistributed profits cannot automatically become a reserve and that somebody possessing the requisite authority must clearly indicate that a portion thereof has been earmarked or separated from the general mass of profits with a view to constituting it either a general reserve or a specific reserve, (b) the surrounding circumstances should make it apparent that the amount so earmarked or set apart is in fact a reserve to be utilised in future for a specific purpose and on a specific occasion”………

11. It is necessary at this stage to advert to s. 80 of the Companies Act, 1956, the material provisions of which are as follows:

“(1) Subject to the provisions of this section, a company limited by shares may; if so authorised by its articles, issue preference shares which are, or at the option of the company are to be liable, to be redeemed:

Provided that—

(a) no such shares shall be redeemed except out of profits of the company which would otherwise be available for dividend or out of the proceeds of a fresh issue of shares made for the purposes of the redemption;……………

(d) where any such shares are redeemed otherwise than out of the proceeds of a fresh issue there shall, out of profits which would have been available for dividend, be transferred to a reserve fund, to be called the capital redemption reserve account, a sum equal to the nominal amount of the shares redeemed; and the provisions of this Act relating to the reduction of the share capital of a company shall, except as provided in this section, apply as if the capital redemption reserve account were paid-up share capital of the company.

(2) Subject to the provisions of this section, the redemption of preference shares thereunder may be effected on such terms and in such manner as may be provided by the articles of the company………….

(5) The capital redemption reserve account may, notwithstanding anything in this section, be applied by the company, in paying up unissued shares of the company to be issued to members of the company as fully paid bonus shares.”

12. From the above section it appears that the redemption of redeemable preference shares is a right conferred on the company and not on the holders of such shares who cannot call upon the company for redemption. It also appears that even when the company decides to redeem such shares it is not bound to fall back upon the reserve created for the purpose of such redemption. It is open to the company to issue new shares in lieu of the redeemed shares. It appears further that the company can utilise its capital redemption reserve for the purpose of issuing fresh paid-up shares to its existing shareholders. Therefore, such a reserve, not earmarked for a known liability, does not fall within the positive definition of a “provision” in Schedule VI of the Companies Act.

13. Applying the tests laid down by the Supreme Court in Vazir Sultan Tobacco Co. Ltd.'s case, [1981] 132 ITR 559 it appears to us that the capital redemption reserve is an amount earmarked or set apart to be utilised in future for a specific purpose or on a specific occasion if necessary and as such it fulfils the tests of a reserve. In addition, we note that capital redemption reserve has been particularly included under the heading “reserve” in the form of balance-sheet as provided for in Schedule VI of the Companies Act. Taking into account all the relevant factors including the dictionary meaning of the expression “reserve” and the intention for making such a reserve, in our view, the item “capital redemption reserve” is a reserve and not a provision within the meaning of the said Act as also the Companies Act and must be included in the capital in an assessment under the said Act.

14. For the above reasons we answer question No. 1 also in the affirmative and in favour of the assessee. There will be no order as to costs.

Suhas Chandra Sen, J.:— I agree.