New India Assurance Co. Ltd. v. Commissioner Of Income-Tax

Kania, J.:— This is a reference made by the Income-tax Appellate Tribunal to the Court under Section 66(1) of the Income-tax Act, referring two questions for the opinion of the Court. The first question is:

“Whether the Income-tax deducted at source of Rs. 33,860 and the Income-tax reserve created by the company of Rs. 1,00,770 are the amounts expended or reserved for on behalf of the policy-holders within the meaning of R. 3(a) of the rules made under Section 10(7) of the Income-tax Act?”

2. Section 10(7), Income-tax Act, provides:

“Notwithstanding anything to the contrary contained in Ss. 8, 9, 10, 12 or 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the Schedule to this Act.”

3. The assesses, company carries on life insurance and various other kinds of insurance business. In the schedule annexed to the Indian Income-tax Act, there are rules for the computation of the profits and gains of insurance business. Rule 1 provides that in the case of life insurance business the profits and gains should be separately computed. Therefore, even though the assessee-company carries on different kinds of insurance business, in respect of its life insurance business a separate computation of its profits and gains must be made. Rule 2 provides for two methods of computation: (a) the gross external incomings of the preceding year from that business less the management expenses of that year (as defined and subject to limitations found in R. 5 and the later part of R. 2): and (b) the annual average of the surplus disclosed by the actuarial valuation, less the deductions mentioned in Sub-r. (2). Rule 2 further provides that taxing authorities are entitled to tax the assessee on whatever be the greater figure of the two. Rule 3 provides:

“In computing the surplus for the purpose of R. 2:—

(a) one-half of the amounts paid to or reserved for or expended on behalf of policy-holders shall be allowed as a deduction.”

4. The scheme, therefore, is that, while under R. 2(b) the surplus has to be ascertained as therein mentioned, in computing the surplus the allowance provided by R. 3(a) must be included.

5. The assessee-company had its last actuarial valuation for three years ending on 31-3-1936, and that valuation report, with the annextures contained in the schedule as required by the Insurance Act, was submitted before the Tribunal. The first question submitted for our opinion requires consideration of two items found in the consolidated revenue account for the three years ending on 31-3-1936. The sum of Rs. 33,860-2-1 is on the credit side for the Income-tax on interest accrued on the life fund during the three years in question. On the other side, in preparing the said consolidated revenue account, the company has debited, in addition to depreciation on furniture and the amount transferred to reserve for bad and doubtful debts, a sum of Rs. 1,00,770.7.6 being reserve for income-tax and super-tax. It is clear that this consolidated revenue account prepared by the assessee-company is in accordance with Form G in sch. 4 to the Insurance Act. On the footing of this revenue account the actuary prepared the report and arrived at the surplus of Rs. 7,17,282-7-0. In the process of assessment before the Tribunal, the opening balance of the previous valuation was deducted. Amounts, which were not liable as expenditure under S. 10, were excluded. In fact, therefore, they were added to the surplus. Having reached that stage, the Tribunal appears to have considered the operation of R. 3(a). In para. 5 of its judgment the Tribunal has stated that any item, which has been taken into consideration in arriving at the surplus under R. 2(b), cannot be claimed as a deduction under R. 3(a). It further stated as follows:

“Rule 3(a) would come into operation after the surplus has been arrived at under R. 2(b). So that R. 3(a) will come into operation only in cases where any amounts have been reserved or expended on behalf of the policy-holders after the surplus has been computed by the actuarial valuation.”

6. It seems to us that this approach is incorrect. Rule 3 opens with the words “In computing the surplus.” The Tribunal has erroneously read those words as meaning “After computing the surplus.” Obviously that is not what is intended by the Legislature in framing R. 2(b) and R. 3(a). The obvious scheme is that, in arriving at the surplus, required to be determined under R. 2(b) and on which, if the figure was higher than the figure arrived at under R. 2(a), the tax is to be levied, the taxing authorities must take on the one side the actuarial valuation surplus, deduct from that the balance of the previous actuarial valuation surplus, and add such amounts by way of expenditure as are not permitted to be deducted on the grounds of expenditure under S. 10, and also (and not afterwards) give by way of deduction what is permitted under R. 3(a). It seems to us that because certain items were disallowed as expenditure under S. 10, they would not, therefore, necessarily have to be excluded, even if they fell under R. 3(a), in arriving at the surplus required to be ascertained under R. 2(b). The question whether the amount in, question was paid to or reserved for or was expended on behalf of the policy-holders, is a question of fact. It is for the tribunal to deter, mine whether the amounts claimed to be deducted fell under any of those three classes. To come to that conclusion they have to ascertain facts. Their conclusion on those facts will be included in computing the surplus which they have to determine. In the words of Lord Simon in (1942) 10 I.T.R (Sup.) 271 the question, whether on the facts ascertained the conclusion is justified or not, is itself a question of law; and it will be open to the Tribunal to refer that question to the Court. Having regard to what the Tribunal has stated, we are unable to hold that they have determined the question of fact at all. They have, in our view, erroneously interpreted the application of Rr. 2 and 3. The judgment only contains their interpretation of those two rules in the schedule to the Income, tax Act. We, therefore, send back the reference to the Tribunal to ascertain the necessary facts and submit the questions which, in their opinion under those circumstances arise for the opinion of the Court. Costs, costs in the reference.

7. Before The Tribunal submitted a fresh and fuller statement of facts, and the same question as before. There was a fresh hearing of the reference before Stone, C.J and Chagla, J.

8. Stone, C.J:— This matter came before my learned brother Sir Harilal Kania and myself on 10th November, 1944, when we sent the reference back to the Tribunal to ascertain certain additional and necessary facts. We then pointed out that the Tribunal had made an incorrect approach to Rr. 2(b) and 3(a) of the schedule to the Income-tax Act to which I will presently refer. The point which arises when analysed resolves itself into an extremely narrow one. By Section 10(7) of the Income-tax Act, it is provided that notwithstanding anything to the contrary contained in Ss. 8, 9, 10, 12 or 18, the profits and gains of any business of insurance and the tax payable thereon shall be computed in accordance with the rules contained in the schedule to the Act. Turning to the schedule it will be found that K. 1 provides:

“In the case of any person who carries on, or at any time in the preceding year carried on life insurance business, the profits and gains of such person from that business shall be computed separately from his income, profits and gains from any other business.”

9. Rule 2 provides:

“The profits and gains of life insurance business shall be taken to be either.”

10. Then two alternatives are given, and it is the greater which is to be taken. In this case it is the second alternative, viz. that which is lettered (b) which is relevant; it provides:

“The annual average of the surplus arrived at by adjusting the surplus or deficit disclosed by the actuarial Vitiation made for the last inter-valuation period ending before the year for which the assessment is to be made, so as to exclude from it any surplus or deficit included therein which was made in any earlier inter-valuation period and any expenditure other than expenditure which may under the provisions of S. 10 of this Act be allowed for in computing the profits and gains of a business, whichever is the greater.

11. But it is to R. 3 to which importance is attached in this case:

“In computing the surplus for the purpose of rule 2,—

(a) one-half of the amounts paid to or reserved for or expended on behalf of policy-holders shall be allowed as a deduction.

12. It is under that sub-rule that the three sums with which we are concerned are said to fall. In remitting their supplemental case, the Tribunal has not raised any fresh question. Therefore, the questions which we have to consider are those which are to be found in the original case which are:

“(1) Whether income-tax deducted at source of Rs. 33,860 and the income-tax reserve created by the company of Rs. 1,00,770 are the amounts expended or reserved for or on behalf of the policy holders within the meaning of R. 3(a) of the rules made under Section 10(7) of the Income-tax Act?”

(2) Whether the assessee is entitled to a deduction under R. 3(a) of half the amount of Rs. 14,142 being the unappropriated carry-forward to the subsequent valuation period?

13. On behalf of the assessee, the insurance company, Sir Jamshedji Kanga has submitted that any amount which the company expends out of its life fund is an expenditure on behalf of its policy-holders, because they are virtually the owners of the fund. With regard to that submission the following further material is to be found in the supplemental case, para. 9:

“The actuary had taken into account in preparing the consolidated revenue account two items, viz., Rs. 33,860 as income-tax paid, and Rs. 1,00,770 being the reserve for income-tax and super-tax. Under R. 2(b) only such items are allowed as a deduction as are allowable under Section 10 of the Income-tax Act. Both these items cannot be allowed as an expenditure under Section 10 of the Income-tax Act. The assessee company does not object to the deduction of the above two items as provided under S. 10, but it is contended that the company is entitled to the deduction of one-half of the above two items, as these amounts have been paid to or reserved for or expended on behalf of the policy-holders, as provided under R. 3(a). In support of this contention the assessee company relied upon the following evidence:—”

14. Then are set out, first of all, a resolution and a quotation from the prospectus, the effects of which are to show that the policy-holders of participating policies are entitled to 90 per cent, of the life fund, whereas the remaining 10 per cent, goes to the shareholders.

15. On the other hand, Mr. Setalvad on behalf of the Income-tax authorities submits that income-tax paid by the insurance company is paid on behalf of itself and no one else, and in support of that proposition the case in 42 Bom. L.R 572 is relied upon, as is also a case in the House of Lords, 1940 A.C 513, in which Lord Atkin at p. 66 said that the company pays Income-tax in discharge of its own liability and not as agents for its shareholders. Be it observed that policy-holders are still further removed than shareholders in their relationship with the company and that their rights rest in the contracts provided by their policies. In my judgment this argument is well founded. So far as the sum of Rs. 33,860 is concerned, it represents the amount deducted at source from the interest payable to the company on its invested funds and it is, therefore, deducted in part discharge of the liability of the company to pay its own taxes. It is to be observed that there is no such provision, as Section 49-B of the Income-tax Act, which could apply to policy-holders, that section was enacted to give special rights to shareholders in respect of Income-tax paid by the company of which they are members. I cannot see how it can be said that this Ss. 33,860 has been paid on behalf of the policy-holders, especially is this so when there is no liability whatever on them to pay this amount.

16. With regard to Rs. 1,00,770, this is a provision which under the Insurance Act must be made by the insurance company, and it is a liability which must be provided for before the surplus can be shown in the revenue accounts of the life department. In the company's annual revenue accounts of the life department no figures in respect of Income-tax are shown except a single separate figure for each of the three years, the total of these figures for the three years is the sum of Rs. 1,00,770. In each year there is in fact a separate amount reserved, and these annual reservations are no doubt adjusted when it is discovered whether the reserve of the preceding year was more or less than the actual amount which had to be paid to discharge the Income-tax. In my opinion, this sum of Rs. 1,00,770 cannot be said to be reserved for or expended on behalf of the policy holders any more than the sum of Rs. 33,860. Even if it could, the deduction would have to be brought back again under the proviso to R. 2(a), whereby it is laid down that if any amount so reserved for policyholders ceases to be so reserved, and is not paid to or expended on behalf of policy-holders, one-half of such amount, if it has been previously allowed as a deduction, shall be treated as part of the surplus for the period in which the said amount ceased to be so reserved. But in my opinion that provision never becomes operative, (because neither the Rs. 33,860/- nor the Rs. 1,00,770 is a permissible deduction under R. 3(a).

17. That leaves the second question with regard to a sum of Rs. 14,141, which is to be found in the accounts described as a carry-forward to the credit of policy-holders. Sir Jamshedji Kanga on behalf of the insurance company has stated in this Court that the Rs. 14,141 is not only carried forward to the credit of the policyholders, but is earmarked for the policy-holders and that it will be used for no other purpose. On that statement by counsel being made Mr. Setalvad on behalf of the Commissioner does not press the matter further, and this sum must be treated as a permissible reserve for policy-holders within the terms of R. 3(a). The answer to the questions, therefore, which I propose is that question no. 1 be answered in the negative and question No. 2 in the affirmative.

18. Chagla, J.:— I agree. The first contention raised by Mr. Setalvad is that the question referred to us,

“Whether the Income-tax deducted at source of Rs. 33,860 and the Income-tax reserve created by the company of Rs. 1,00,770 are the amounts expended or reserved for on behalf of the policy-holders within the meaning of R. 3(a) of the rules made under S. 10(7). Income-tax Act”

19. Is a question of fact, and Mr. Setalvad says that inasmuch as the Tribunal has come to the conclusion that these sums are not reserved for nor expended on behalf of the policy-holders, we cannot go behind that finding of fact. I do not accept that contention of Mr. Setalvad. The question referred to us is a question of law. We have been asked to consider whether the conclusion arrived at by the Tribunal from admitted or proved facts is a conclusion justified in law, whether the conclusion is justified on a true construction of R. 3(a) of the rules framed under the Income-tax Act.

20. Now, the question of the applicability of a section or the construction of a section is always a question of law. Mr. Setalvad has relied, and from his point of view rightly relied, on an expression used by Kania, J. when he referred this matter back to the Tribunal for a further statement of facts, the expression being that the question whether the amount in question was paid to or reserved for or was expended on behalf of the policy-holders is a question of fact I do not think it is fair to the learned Judge to wrench that expression from its context. When one looks at the context, it is clear, what the learned Judge means, and really, if the question referred to us was a question of fact, I fail to see the necessity for referring it back to the Tribunal for a further and better statement of the case.

21. Now the scheme of Rr. 2 and 3 framed under Section 10(7) of the Income-tax Act to my mind is perfectly clear. The profits and gains of a life insurance business are to be assessed under R. 2(b) on the surplus arrived at on an actuarial valuation subject to certain deductions and additions. First the actual surplus arrived at by the actuary is to be taken as the basis. Then under R. 2(b) there is to be excluded from that surplus two amounts, first any surplus or deficit which is included in it which was made in any earlier inter valuation period and does not belong to the valuation period under consideration and the second amount to be excluded is all such expenditure as is not permissible under Section 10 of the Income-tax Act. Then under R. 3 certain deductions are allowed and the most important deduction and the one which we have got to consider for the purpose of this reference is the deduction permitted under R. 3(a) which is one half of the amounts paid to or reserved for or expended on behalf of policy-holders. Now under Section 13 of the Insurance Act an actuarial report and abstract have got to be prepared as part of the statutory obligation of a life insurance company, and in sch. iv to that Act a form is given, Form G, which lays down the manner in which a consolidated revenue account has to be prepared. It is important to note that in this form one of the items of expenditure shown on the debit side is taxes paid in United Kingdom, British India, Dominion and Foreign countries and on the credit side is shown interest, dividends and rents but less Income-tax thereon, which undoubtedly means Income-tax deducted at the source. Therefore, in order to arrive at a proper actuarial surplus, the Insurance Act requires that certain expenses must be first deducted and among those expenses are payment of income-tax. Therefore, before the surplus in this case of Rs. 7,17,282-7-0 was arrived at by an actuarial calculation, the sum of Rs. 1,00,770-7-6 was debited as transferred to reserve for Income-tax and super-tax and also the sum of Rs. 33,860 was deducted from the interest earned as Income-tax deducted at the source. What the actuary was doing was what he was bound to do under the law, viz., to make these deductions before he certified that the surplus was Rs. 7,17,282-7-0.

22. Now I fail to understand, with great respect to Sir Jamshedji Kanga, the argument that if these two deductions were not provided for in the account books, the surplus would have been increased by the same amount. Whether entries were made to this effect in the account books or not, I fail to see how the surplus could have been increased which could have been divisible among the shareholders. The contract between the company and the shareholders, which is referred to in the supplementary statement, is that 90 per cent, of the profits, after making the necessary provisions, is to be ap-portioned among the holders of participating policies and it cannot possibly be urged that one of the necessary provisions is not the payment of Income-tax. Therefore, and after all the only relationship between the company and its policyholders is a contractual one, under the contract a policy-holder can only claim to be entitled to 90 per cent, of the profits after proper expenditure has been incurred, and one of those items of expenditure would be the payment of Income-tax.

23. The real question we have to consider is whether these two amounts have been reserved for or expended on behalf of the policy-holders. Sir Jamshedji Kanga has rightly conceded that there is no difference in principle between these two amounts; the sum of Rs. 33,860-2-1 has been actually expended, the sum of Rs. 1,00,770-7-6 is not expended but it is kept in reserve to meet a liability similar to the liability for which Rs. 33,860-2-1 was expended.

24. It is not disputed and it cannot be disputed that the assessee in this case is the company. The liability to pay the tax is on the company. There is no liability to pay the tax on the policy-holders, and the amount of Rs. 33,860-21 was paid by the company not on any one else's behalf but on its own behalf in order to discharge a liability which in law it has to discharge for paying Income-tax. Similarly the sum of Rs. 1,00,770-7-6 is reserved by the company to meet a liability which again is in law its own liability and not the liability of the policy-holders. In face of that I find it very difficult to appreciate Sir Jamshedji Kanga's argument that these two amounts were either expended or reserved on behalf of the policyholders.

25. With regard to the sum of Rs. 14,142, I really fail to understand how the Tribunal in face of the appropriation account came to the conclusion that this was the unappropriated surplus. In the total which is placed to the credit of the policy-holders, viz., es. 6,50,734 the sum of Rs. 14,142 is included. Instead of paying out the whole of this amount, what the appropriation account does is, it pays out or makes provision for the payment of Rs. 6,32,063 to the policy-holders, provides for es. 4530, which is the interim bonus already paid, and carries forward the balance of Rs. 14,141 to the credit of the policy holders.

26. It is already appropriated, remains appropriated and is carried forward as appropriated to the credit of the policy-holders. To remove all ambiguity Sir Jamshedji Kanga has made a statement, as referred to by the learned Chief Justice, on behalf of the company, that this sum is earmarked for the policy-holders and will not be utilised for any other purpose. Under the circumstances I agree with the learned Chief Justice that the questions referred to us should be answered in the manner he has suggested.

27. Per Curiam.— We think that in the circumstances each party should pay his own costs.

28. Reference answered.