Sabyasachi Mukharji, J.— These two appeals were heard together. Civil Appeal No. 1665 of 1974 arises from the decision of the High Court of Allahabad in Income Tax Reference No. 195 of 1971.
2. The assessee, Elgin Mills Ltd., at the relevant time, was a public limited company engaged in the business of manufacture of textile goods. The assessment year involved is the year 1964-65 of which the relevant previous year ended on September 30, 1963. For the purposes of assessment under the provisions of Companies (Profits) Surtax Act, 1964, a dispute arose between the assessee and the revenue with regard to the computation of “standard deductions”. The company claimed that the following amounts should be treated as reserves for the purposes of computation of its capital:
“(a) Investment reserve — Rs 85,00,000
(b) Rehabilitation reserve — Rs 40,00,000
(c) Forfeited Dividend reserve — Rs 96,374”
3. The Income Tax Officer did not include any of the said “reserves” in the capital of the assessee Company on the basis that these did not represent reserve in the real sense. On appeal, the Appellate Assistant Commissioner held that the Rehabilitation reserve and Forfeited Dividends reserve represented reserves but the Investment reserve account did not constitute real reserve. Both the assessee as well as the revenue went up in appeal before the Tribunal. The Tribunal disposed of these appeals by a similar order along with two similar appeals relating to Assessment Year 1963-64 which arose out of proceedings under the Super Profits Tax Act, 1963. The Tribunal held that all the three accounts represented reserves for the purposes of assessment under the Super Profits Tax Act, 1963. The Tribunal was further of the view that all the three represented reserves for the purposes of assessment under the Super Profits Tax Act, 1963 and as the principle involved was the same as under the Companies (Profits) Surtax Act, 1964, the Tribunal held that the amounts in question represented reserves under the latter Act also. At the instance of the Commissioner, reference was made to the High Court for Assessment Year 1964-65 on the following questions:
“(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in arriving at its decision by applying the principles laid down in the Second Schedule to the Super Profits Tax Act, 1963, instead of the provisions of the Second Schedule to the Companies (Profits) Surtax Act, 1964, for computation of capital of the assessee company for Assessment Year 1964-65.
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that
(a) Investment reserve
(b) Rehabilitation reserve
(c) Forfeited Dividend reserve
were includible in the capital computation of the company in accordance with the Second Schedule to the Companies Profits (Surtax) Act, 1964.”
4. The High Court noted that in the connected Reference No. 196 of 1971 — CIT v. Elgin Mills Co. Ltd. (decision dated July 19, 1973) arising out of proceedings under the Super Profits Tax Act, 1963, it had already held that these accounts in question constituted reserve in the real sense and as such should be taken into consideration in determining the standard deductions under Section 9(2) of the Act, 1963. It was not disputed before the High Court that if the present reference had been under the Super Profits Tax Act, 1963, the accounts in question would have to be held as reserves by the High Court in view of its previous judgment. But it was contended that the provisions of the Companies (Profits) Surtax Act, 1964 were different from the provisions of the Super Profit Tax Act, 1963. The High Court did not accept this contention. The High Court was of the view that under both the Acts, charging sections (Section 4) were identically worded except that the expression “standard deduction” in Super Profits Tax Act, 1963 had been replaced by the expression “statutory deductions” in the Companies (Profits) Surtax Act, 1964. Under both Acts these deductions had to be computed with reference to the capital employed in the assessee Company. Under both the Acts reserves of the company were to be treated as its capital and the only difference was in the Second Schedule to the Companies (Profits) Surtax Act, 1964, an explanation had been added. The said explanation was to the following effect:
“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 Schedule 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.”
5. This explanation, the High Court noted, merely clarified what was implicit in the Super Profits Tax Act, 1963. Item 5 in the prescribed balance-sheet under the Companies Act is “Surplus” i.e balance in profit and loss account after providing for proposed allocations, namely, dividend, bonus, or reserves. Item (6) was “Proposed additions to Reserves” and item (7) was “Sinking Funds”. The accounts mentioned in the explanation would not form a reserve for the purposes of the computation of capital of a company. In any case the High Court was of the view that none of the accounts in dispute fell under the heading “current liabilities”. It was contended before the High Court on behalf of the revenue that any amount credited to those accounts during the relevant previous year would fall in Item 6 viz. proposed additions to reserves. The High Court found that there were no additions to those funds during the relevant previous year inasmuch as the amount standing in those accounts were being brought forward from year to year. In those circumstances the Tribunal was right in deciding the question with regard to the admissibility of the three accounts in question on the principle application (sic applicable) to Super Profits Tax Act, 1963. This Court in Vazir Sultan Tobacco Co. Ltd. v. CIT (1981) 4 SCC 435, (1981) 132 ITR 559 held that the expression “reserve” in Super Profits Tax Act, 1963 and the Companies (Profits) Surtax Act, 1964 are in pari materia.
6. On merits, it was agreed that the points were covered by the previous decision of the High Court in the case of CIT v. British India Corpn. (P) Ltd. (1973) 92 ITR 38 (All) Accordingly, the High Court answered both the questions in the afFirmative and in favour of the assessee. This appeal arises out of the said decision of the High Court. In CIT v. British India Corpn. (P) Ltd. (1973) 92 ITR 38 (All) the High Court noted the distinction between “provision” and “reserves” and observed that when an amount was set apart for a future liability, it was called a reserve and when it was set apart to meet an existing liability, it was called a provision. The High Court was of the view that the Tribunal in that case was right in holding that capital reserve, stocks and stores reserves, bad and doubtful debts reserves, obsolescence reserve, loans and insurance reserves and investment reserves were to be included in the computation of capital. The Tribunal was not right in including, according to the High Court, forfeited money reserve as the assessee had been transferring to this account dividends which had not been collected by the shareholders after they had been declared, and as and when the shareholders made a claim, made payments and debited the same to the account. The High Court, therefore, was of the view that this account represented a provision in respect of an existing liability.
7. The High Court in Income Tax Reference No. 196 of 1971 had to deal with investment reserve account, rehabilitation reserve account, capital reserve account and depreciation reserve account and held these were reserves but the account maintained as dividend account did not represent reserve.
8. The High Court in its judgment noted that on July 19, 1973 relying on other judgment in Income Tax Reference No. 200 of 1971 decided on July 19, 1973 in CIT v. Saran Engineering Co. Ltd. (1986) 3 SCC 662 had answered the question by saying that the aforesaid items were reserves. This is the subject-matter of Civil Appeal No. 1599 of 1974 which will also be disposed of by another judgment of this Court (1986) 3 SCC 662.
9. Civil Appeal No. 1665 of 1974 and Civil Appeal No. 145 of 1976 which arose out of the Income Tax Reference No. 196 of 1971 have been heard together and are being disposed of by this judgment.
10. In this connection it would be desirable to dispose of Civil Appeal No. 145 of 1976 separately first. It was submitted that the assessee had shown capital of Rs 2,63,79,218 which included the aforesaid reserves including investment reserves, rehabilitation reserve, capital reserve, depreciation reserve and forfeited dividends. The submission on behalf of the revenue by Sree Dalip Singh was that the amount of Rs 85 lakhs in the relevant year as investment reserve was set apart by the assessee Company to meet the liabilities of its Bombay subsidiaries, M/s Madhav Mills Ltd. and Calico Processors Ltd. which were known to the assessee on the date of the balance-sheet. The Directors' report, according to the revenue, left no room for doubt that these were anticipated losses of the assessee Company in the form of the investments made in its Bombay subsidiaries known at the date of the balance-sheet. These were liabilities, according to Sree Singh actually staring in the face of the assessee company when it prepared the balance-sheet. The Tribunal had held that it was a reserve because it was formed by transfer of the amount from capita1.general reserve. This according to the revenue, could not be accepted. Revenue submitted that it was a common ground that originally the amount was set apart out of the undistributed mass of profits and therefore the moment it was taken out of the capital or general reserve, it ceased to be a capital or general reserve, and but for its being set apart to meet the liabilities of its subsidiaries, it had again gone back and formed part of the undistributed mass of profits and thereby assumed its original character. It was submitted that the reserve in order that it might be so called in the real sense of the term must come out of the profits of the company. But if reserves were constituted out of assets which were sold or by any other means it would be difficult to term the amounts shown as reserve. It was submitted that the investments by the assessee Company in the Bombay subsidiaries were in the nature of bad and doubtful debts. Therefore, these were dead losses of the assessee Company as the holding company, and these amounts were ultimately bound to be written off and according to the revenue's submission, the substance of the matter clearly was that the amount of Rs 85 lakhs though shown as a reserve, was, in fact, a provision to meet the anticipated losses or bad and doubtful debts in the shape of investments in the two subsidiaries aforesaid which were shown at the date of the balance-sheet.
11. For the assessee Sree Salve drew our attention to the distinction between reserve and provision which has been discussed in the decision of this Court in Metal Box Co. Ltd. v. Workmen. AIR 1969 SC 612, (1969) 1 SCR 750, (1969) 73 ITR 53
12. According to the revenue, the nature and object of the subsidiary companies have to be kept in view and the practical result, revenue contended before us, was that the shareholders of the holding company whose share capital had been employed for the flotation of the subsidiary companies had not only no power to control the dealings of the subsidiary companies but in fact had no knowledge of, nor any right to the knowledge of or dealings of the subsidiary companies.
13. The expressions “Provision” and “Reserve” are defined in Schedule VI Part III to the Companies Act, 1956. In the decision of this Court in Vazir Sultan case (1981) 4 SCC 435, (1981) 132 ITR 559 it has been held that a provision was meant to provide for any known liability and the substance of the matter had to be kept in view. It was further submitted by Sree Singh that the depreciation reserve could not be considered to be reserve in the real sense at all. Forfeited dividends reserve of Rs 1,08,771 had to be a provision.
14. On the other hand, on behalf of the revenue, it was submitted that in order to constitute reserve, there must be an appropriation of profits current or accumulated and not a charge against the profits for the year. The conduct must bear out the intention to create a reserve. It must not be to set apart to meet any known liability, a liability known but existing on the date of the balance-sheet. The expression “reserve” has been defined in the textbooks of accountancy which has been noted by this Court. It was urged that it could not be disputed that reserve might be general or specific reserve, what was required was that amount should be kept apart for one or the other purpose either general or specific. The distinction between provision and reserve must be found out bearing in mind main features of the reserve. These are (1) It must he an appropriation of profits, current or accumulated and not a charge against the profits for the year. (2) The conduct of the parties must bear out that intention. (3) It must not be to set apart to meet any known liability, a liability known to exist on the date of the balance-sheet. Reference in this connection may be made to the observations of this Court in Vazir Sultan case (1981) 4 SCC 435, (1981) 132 ITR 559 at p. 569-70. The Calcutta High Court in CIT v. Eyre Smelting (P) Ltd. (1979) 118 ITR 857 (Cal) noted the characteristics of “provisions” as well as “reserves”. It held, inter alia, that provisions were made against anticipated losses and contingencies, it held further that an amount set aside of the profits designed to meet a contingency or liability or commitment or diminution in the value of the assets known to exist would be a reserve, and an amount set aside to provide for a known liability to which the amount cannot be determined with substantial accuracy would be a provision. The said High Court differed from the decision of the Allahabad High Court in British India Corpn. (P) Ltd. (1973) 92 ITR 38 (All) in respect of ‘bad and doubtful debts’. Whether in respect of bad and doubtful debts the account could be treated as reserve or provision would depend upon the facts and circumstances of the case.
15. The distinction between “provision” and “reserve” has been clarified by this Court in Metal Box Co. of India Ltd. v. Workmen AIR 1969 SC 612, (1969) 1 SCR 750, (1969) 73 ITR 53 at pp. 67-68 which states as follows:
“The next question is whether the amount so provided is a provision or a reserve. The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the P&L account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest (see Spicer and Pegler's Bookkeeping and Accounts, 15th Edn., p. 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision: (see William Pickles' Accountancy, 2nd Edn., p. 192; Part III, clause 7, Schedule VI to the Companies Act, 1956; which defines provision and reserve).”
16. This Court in CIT v. Standard Vacuum Oil Co. AIR 1966 SC 1393, (1966) 2 SCR 367, (1966) 59 ITR 685 observed that the ordinary meaning of the expression “reserve” was something specifically kept apart for further use or for specific occasion. The observations made therein will have to be understood in the light of the subsequent decisions of this Court in Metal Box AIR 1969 SC 612, (1969) 1 SCR 750, (1969) 73 ITR 53 and Vazir Sultan (1981) 4 SCC 435, (1981) 132 ITR 559.
17. This Court in Vazir Sultan Tobacco Co. Ltd. v. CIT (1981) 4 SCC 435, (1981) 132 ITR 559 considered the expression “reserve” in the Super Profits Tax Act, 1963 and Companies (Profits) Surtax Act, 1964. It is not necessary to set out all the conclusions of this Court.
18. Our attention was drawn to Datta's on the Company Law (3rd Edn.) at p. 421. “Reserves” consist of appropriations from profits and other surplus and retained for future use. This, however, does not include any amount which had been kept to meet any liability or diminution in value of assets known to exist as on the date of the balance-sheet. The essence and substance of the matter has to be kept in view.
19. As reiterated before, the distinction between “provision” and “reserve” is while the “provision” is a charge of profits which are taken into account in the gross receipt of Profits & Loss Account, “reserve” is an appropriation of profit to provide for the asset which is represented.
20. Keeping these tests and the facts of these appeals in mind, we must hold that the conclusion of the High Court in Civil Appeal No. 1665 of 1974 holding that the investment reserve and rehabilitation reserve were reserves and were entitled to be treated so under the relevant Act is right. But in the facts of the case, the High Court was not right in holding that the forfeited dividend reserve was reserve and Question 2 also in the afFirmative. It should have followed in this respect its previous decision in respect of forfeited dividend reserve in CIT v. British India Corpn (1973) 92 ITR 38 (All). The appeal, therefore fails, except on the point of “Forfeited Dividend Reserve”.
21. In Civil Appeal No. 145 of 1976, we are concerned with five items as mentioned i.e investment reserve, rehabilitation reserve, capital reserve, depreciation reserve and forfeited dividends and in view of the facts found, we are of the opinion that first four items constituted reserves and were entitled to be treated as such under the Act and the forfeited dividends did not represent reserve. This appeal accordingly fails in view of the facts found by the Tribunal and reiterated by the High Court and the principles applicable as mentioned hereinbefore. The High Court in its order had excluded “forfeited dividend account” from the reserve. The High Court was right in so doing.
22. In the facts and circumstances of the case, the parties will pay and bear their own costs in both the appeals.