State
Bank of Patiala, Patiala Vs. The Commissioner of Income-Tax, Patiala [1996] INSC 406 (15 March 1996)
N.P.
Singh, S.P. Bharucha Paripoornan,J.
ACT:
HEAD NOTE:
Leave
granted in all the special leave petitions.
2.
These are all connected cases. The matter arises under the Companies (Profits)
Surtax Act, 1964 (hereinafter referred to as the Act). The parties in all the
appeals are the same. The appellant ln the appeals is "The State Bank of Patiala" and the respondent is the
"Commissioner of Income Tax, Patiala". The Civil Appeals filed from Special leave petitions (C) Nos.
2392-95 of 1993 are the main cases. They relate to four assessment years -
1971-72, 1972-73, 1973-74 and 1975-76. The appellant-assessee set apart amounts
as "reserve" for "bad and doubtful debts" in all the years.
A claim was laid that such sums qualified as reserves for the purpose of Rule 1
(xi) (b) of the First Schedule and Rule 1 (iii) Of the Second Schedule of the
Act and such sums, representing reserves, should be included in the capital of
the appellant for appropriate relief. The Income Tax Officer rejected the
claim. In appeal, the Income Tax Appellate Tribunal allowed the plea of the assessee.
The Income Tax Appellate Tribunal, by its detailed order dated 23.1.1980,
upheld the plea of the assessee and held that the amounts set apart as reserves
are entitled for appropriate relief under Rule 1 (xi)(b) of the First Schedule
and Rule 1(iii) of the Second Schedule of the Act. On motion by the Revenue the
Appellate Tribunal referred the following questions of law for the decision of
the High Court of Punjab and Haryana, which were numbered as Income Tax
Reference Nos.235 to 238 of 1980 :
"i)
Whether, on the facts and in the circumstances of the case, the Appellate
Tribunal was right in law ln holding that the amounts provided by the assessee
for bad and doubtful debts in the balance sheets of the relevant previous years
qualified as reserves for the Purpose of clause xi (b) of Rule 1 of the First
Schedule to the Companies (Profits) Sur-tax Act, 1964 and consequently allowing
yearwise deduction as under:
1971-72
Rs. 7,00,000/- 1972-73 Rs. 13,78,000/- 1973-74 Rs. 22,11,000/- 1975-76 Rs.
15,98,000/- ii) Whether on the facts and in the circumstances of the case, the
Appellate Tribanal was right in law in holding that the amounts of
Rs.15,53,576/-, Rs.27,21,641/-, Rs.29,91,641/- and Rs.47,16,641, provided for
bad and doubtful debts as at the beginning of the relevant accounting year
respectively for the assessment years 1971- 72, 1972-73, 1973-74 and 1975- 76
qualified as a reserve for inclusion in the capital of the assessee under
Second Schedule ot the companies {Profits) sur-tax, Act,1964." (emphasis
supplied) By a detailed judgment dated 27.7.1992 the High Court took the view
that on the facts and circumstances of the present case, sums of money set
apart by the assessee as reserves are really "provisions" and not
"reserves" and so, such sums are not entitied to the relief granted
by the Appellate Tribunal. It is, thereafter the assessee moved this Court by
special leave petition Nos. 2392-95 of 1993 and obtained special leave in the
four cases. The judgment of the High Court is reported as Commissioner of
Income Tax vs. State Bank of Patiala (203
ITR 150).
3.
Special leave petitions (C) Nos. 27543-5Q of 1995 relate to the same assessee
and eight assessment years are involved therein - 1979-80 to 1987-88 escept
1985-86. For those years, identical claim put forward by the appellant- assessee
was rejected by the Income Tax Officer. In appeal, CIT allowed the claims. In
the meanwhile, the decision of the High Court for the previous four years,
i.e., 1971-72, 1972-73, 1973-74 and 1975-76 had been rendered and so the
Tribunal, following the decision of the High Court, held against the assessee.
The plea of the assessee to refer the matter either to the appropriate High
Court or to this Court was disallowed. The assessee has filed special leave
petitions in this Court directly against the aforesaid order of the Appellate
Tribunal.
4.
Special leave petition (C) No. 27551 of 1995, relating to the same assessee and
involving consideration of the same question, relates to the assessment year
1985-86. The Appellate Tribunal finally decided against the assessee following
the earlier decision of the High Court reported in 203 ITR 150. The attempt to
get the matter referred to the High Court was unsuccassful and so the assessee
filed the special leave petition in this Court against tne order of the Appelate
Tribunal.
5. All
the 13 appeals involve conslderation of the same question between the same
parties. So, they were heard together and are disposed of by this common
judgment.
6. We
heard counsel for the appellant-assessee, Mr. A. Subba Rao, and counsel for the
respondent Revenue, Mr. B.S. Ahuja.
7. The
statutory provisions, relevant for our purpose, are mentioned here in below:
The
Companies (Profi_s) Surtax Act 1964 {Act 7 of 1464) "2(5) "chargeable
profits" means the total income of an assessee computed under the
Income-tax Act, 1961 for any previous year or years, as the case may be, and
adjusted in accordance with the provisions of the First Schedule;
(8)
"Statutory deduction" means an amount equal to fifteen per cent of
the capital of the company as computed in accordance with the provisions of the
Second Schedule, or an amount of two hundred thousand rupees, which ever is
greater:
Provided
that where the previous year is longer or shorter than a period of twelve
months, the aforesaid amount of fifteen per cent or, as the case may be, of two
hundred thousand rupees shall beincreased or decreased proportionately:
Provided
further that where a company has different previous years in respect of its
income, profits and gains, the aforesaid increase or decrease, as the case may
be, shall be calculated with reference to the length of the previous year of
the longest duration; and (9) all other words and expressions used herein but
not defined and defined in the Income-tax Act shall have the meanings
respectively assigned to them in that Act." "4. Charge of tax. -
Subject to the provisions contained in this Act, there shall be charged on
every company for every assessment year commencing on and from the first day cf
April, 1964 [but before the first day of April, 1988], a tax (in this Act
referred to as the surtax) in respect of so much of its chargeable profits of
the Previous year or previous years, as the case may be, as exceed the
statutory deduction, at the rate or rates specified in the Third Schedule.~'
"THE
FIRST SCHEDULE" ( See Section 2(5) ) RULES FOR COMPUTING THE CHARGEABLE
PROFITS In computing the chargeable profits of a previous year, the total
income computed for that year under the Income Tax Act shall be adjusted as
follows:
1.
Income, profits and gains and other sums falling within the following clauses
shall be excluded from such total income, namely:
xxxx xxxx
xxxx (xi) in the case of a banking company (a) any sum which during the
previous year is transferred by it to a reserve fund un.der subsection (1) of
section 17 of the Banking Companies Act, 1949 or is deposited by it with the
Reserve Bank of India under sub-clause (ii) of clause (b) of sub-section (2) of
section 11 of that Act, not exceeding the amount required under the aforesaid
provisions to be so transferred or deposited, as the case may be, or (b) any
sum transferred by it during the previous year to any reserves in India
including reserves not shown as such in its published balance sheet in so far
as the sums transferred to such reserves are attributable to income chargeable
to tax under the Income-tax Act and have not been allowed as a deduction in
computing its total income under that Act and in so far as the aggregate of
such sums does not exceed the highest of the aggregate of such sums, if any, so
transferred during any one of the three years prior to the previous year,
whichever is higher;
xxx xxx
xxx [Explanation - Notwithstanding anything contained in any clause of this
rule, the amount of any income or profits and gains which is required to be
excluded from the total income under that clause shall be only the amount of
such income or profits and gains as computed in accordance with the provisions
of the Income-tax Act (except Chapter VIA thereof), and in a case where any
deduction is required to be allowed in respect of any such income or profits
and gains under the said Chapter VIA, the amount of such lncome or profits and
gains computed as aforesaidas reduced by the amount oi such deduction.]"
"THE SECOND SCHEDULE (See Section 2(8)) RULES FOR COMPUTING THE CAPITAL OF
A COMPANY FOR THE PURPOSES OF SURTAX
1.
Subject to the other provisions contained in this Schedule, the capital of a
company shaIl be the aggregate of the amounts, as on the first day of the
previous year relevant to the assessment year of (i) ............
(ii)
............
(iii)
its other reserves as reduced by the amounts credited to such reserves as have
been allowed as a deduction in computing the income of the company for the
purposes of the Indian Income-tax Act, 1922 or the Income-tax Act, 1961;
(emphasis
supplied)
8. The
facts of these cases are not in dispute. As stated by the High Court the sole
point, which falls for consideration, is whether the amounts set apart by the assessee
during each assessment year for "bad and doubtful debts" in the
balance sheets of the relevant period constitute "reserve" as
contemplated by Rule 1 (xi) (b) of the First Schedule and Rule 1 (iii) of the
Second Schedule to the Act? The Act has levied a charge on every company for
every assessment year - a tax called sur-tax - in respect of so much of its
chargeable profits of the previous years as exceed the Statutory deduction at
the rates specified in the Third Schedule. In determining the chargeable
profits Rule 1 ( X1 ) ( b) of the First Schedule mandates that in the case cf a
banking company any sum transferred by it during the previous year to any
reserves in India including the reserxes not shown as such in its published
balance sheets in so far as the sums transferred to such reserves are
attributable to income chargeable to tax under the Income tax Act and have not
been allowed as a deduction in computing its total income under the Act, shall
be excluded.
The
tax is levied, on the chargeable profits, which excluded the statutory
deduction at the rates specified in the Third Schedule. As per section 2(8) of
the Act statutory deduction is defined to mean an amount equal to ten per cent
of the capital Of the company as computed in accordarce with the provisions of
the Second Schedule. Rule 1 of the Second Schedule mandates that the capital of
the company shall be the aggregate of the amounts taking within its told its
other reserves as specified in Rule 1(iii) of the Second Schedule.
9. If
the sums set apart in the balance sheets are only "provisions" the assessee
will not be entitled to the relief claimed by it. If, on the other hand, the
sums set apart are "reserves" within the meaning of the Act assessee
will be entitled to appropriate relief. After referring to the relevant
decisions, dealing with the reserves and provisions, the Income Tax Appellate
Tribunal posed the question thus:
"
in order to constitute a reserve a particular amount set aside out of the
profits and other surpluses, not designed to meet a liability, contingency,
commitment or diminution in the value of assets known to exist at the date of
the balance sheets, is a reserve. In other words, if the amount set apart is
designed to meet a liability, contingency, commitment or results in diminution
in value of assets, it would be a provision and not a reseQrve. We have to
apply this test here " In paragraphs 20 to 22 of its order, the Appellate
Tribunal entered the following findings:
"We
find that the assessee has not written off or adjust(ed) these amounts provided
as reserves and doubtful debts in its profit and loss account that these
amounts have not been allowed as a deduction computing the income of the
company for purposes of Income- tax Act, that these amounts have remained
employed in the business of the ass;essee by way of capital and the assessee
has in fact treated these amounts as reserves and not as provisions designed to
meet a liability, contingency, commitment, or diminution in the value of assets
known to exist at date of relevant balance sheets.
We,
therefore, hold that these are amounts which constitute reserve for clause liii)
of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act,
1964." "In fact it has been clarified by the learned Counsel for the assessee,
and it has not been controverted by the revenue, that in none of the years
under appeal the assessee appropriated any amounts against bad and doubtful
debts. The reserves stood as they were in each year and therefore, would
constitute reserve within the meaning of rule 1(xi)(b) of the Second Schedule
to the Companies (Profits) Sur-tax Act, 1964." (emphasis supplied) In
paragraph 24 of its order the Tribunal concluded thus:
"We
also find that no amount on account of bad debts was factually written off or
adjusted by the assessee against these agounts claimed as reserves, that in fact
the assessee also did not make a claim for any deduction for any of the
assessment years under consideration on account of bad debts, that no such
claim was either made or allowed by the Income-tax Officer, that the assessee
made contra entries in the unpublished balance sheets only and no such entries
were passed in books and that the published balance-sheets did not contain any
contra entries. The _amounts were in fact treated as reserves. These are
entitled to be considered as reserves under Rule l(xi)(b) of the First Schedule
to the Act. We, therefore, direct that these be so treated Both the issues arc
decided in all the assessment years, in favour of the assessee." (emphasis
suppliad)
10.
The High Court, in answering the questions referred to it, by judgment dated
27.7.1992, adverted to the landmark Commissioner of Income-Tax, A.P. (132 ITR
559), Commissioner of Income-Tax, Kanpur vs. Elgin Mills Ltd. (161 ITR 733) and
stated thus:- "Thus, where a fund has been created to meet a liability
which has actually arisen and jis known on the date of the preparation of the
balance-sheet, it would obviously be provision. Again fund created or a sum of
money set apart to met any liability which the assessee can reasonably and lagitimatly
anticipate on the date of preparation of the balance sheet though the quantum
of that liability is not yet determined, has also been equated with the present
known liability and the fund to meet such liability cannot be treated as a
reserve. If, on the other hand, a fund is created to meet some future unknown
liability which has not lyet arisen and which could not legitimately and
reasonably be anticipated by the assessee at the time of the preparation of the
accounts, the fund would be treated as a 'reserve'. Whether in respect of bad
and doubtful debts, an account could be treated as reserve or a provision would
depand upon the facts and circumstances of each case. Again, whether a
particular liability could reasonably and legitimately be anticipated by a assessee
on the date of the balance sheet would be a question of fact to be determined
in the circustances of each case and the nature of the business carried on by
the assessee would be one relevant factor.
Applying
these tests to the case in hand, one cannot loose sight of the fact that the assessee
before us is a banking company whose primary business, is to lend money. In the
very nature of things, it would be reasonable and legitimate for such an assessee
to assume that in the course of its business, it is bound to have bad and
doubtful debts for which it may in anticipation make a provision in the balance
sheet by having a separate fund or an account to meet such anticipated
liability although its quantum would determined at some later date. Since such anticiapted
liability has been equated with known and existing liability, the fund is to be
considered a 'provision' and not a 'reserve'." (emphasis supplied) The
High Court concluded, thus:- "For the reasons recorded above, we are of
the view that on the facts and circumstances of the present case, the sums of
money set apart by the assessee herein for meeting its anticipated liability
was a 'provision' and the Tribunal erred in law in holding it to be a
'reserve'. In the result, both the questions referred to us are answered in the
negative i.e. against the assessee and in favour of the Revenue." (emphasis
supplied)
11. We
are of the view that the learned judges of the High Court misunderstood and
misapplied the ratio laid down in the decisions of this Court, referred by it.
In Metal Box Co. of India Ltd. vs. Their workmen (73 ITR 53) at pp. 67-68 this
Court laid down the law thus:- "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 ln 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 Book-keeping and Accounts, 15th
edition, page 42). An amount set aside out of profits and other surpluses, not
designed to meet a liability, continqency, commitment or diminution in the
value of assets 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, second edition, p.l92; Part III, clause 7, Schedule VI to the
Companies Act, 1956, which defines provision and reserve)." (emphasis
supplied) In Vazir Sultan Tobacco Co. Ltd. vs. Comissioner of Income- Tax, A.P.
(supra), after referring to the above observations in Metal Box Company's case
(supra), the Court held at p.
569,
thus:- "In other words the broad distinction between the two is that
whereas a provision is a charge against the profits to be taken into account against
gross receipts in the P. & L. account, a reserve is an appropriation of
profits, the asset or assets by which it is represented being retained to form
part of the capital employed in the business." (emphasis supplied) After
referring to the relevant provisions of Companies Act, 1956 regarding the form
of balance-sheet wherein the words "reserve and surplus" and
"current liabilities and provisions" etc. are dealt with, the Court
observed, thus:- "On a plain reading of cl. 7(1)(a) and (b) and cl. 7(2) above
it will appear clear that 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 lntent on 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. We are emphasising
this aspect of the matter because during the hearing almost all counsel for the
assessees strenuously contended before us that once it was shown or became
clear that the retention or appropriation of a sum out of profits and surpluses
was for an unknown liability or for a liability which did not exist on the
relevant date it must be regarded as a reserve. The fallacy underlying the
contention becomes apparent if the negative and non- exhaustive aspects of the
definition of reserve are borne in mind. Having regard to the type of
definitions of the two concepts which are to be found in cl. 7 of Pt. III she
proper approach in ounr view would be first to ascertain whether the particular
retention or appropriatioin of a sum fells within the expression
"provision" and if it does then clearly the concerned sum will have
to be excluded from the computation of capital, but in case the retention or
appropriation of the sum is not a provision as define the question will have to
be decided by reference to the true nature and character of the sum so retained
or appropriated having regard to several factors as mentioned above and if the
concerned sum is in fact a reserve then it will be taken into account for the
computation of capital." (emphasis supplied) In Commissioner of Income-Tax._Kanpur
vs. Elgin Mills Ltd. (supra) the Court stated the guidelines to be borne in
mind to distinguish between 'provision' and 'reserves' in the following words:-
"The distinction between "provision" and "reserve"
must be found out bearing in mind the main features of the reserve. These are:
(1) it
must be an appropriation of profits, current or accumulated, and 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 thsi connection may be
made to the observations of this Court in Vazir Sultan's case [1981] 132 ITR
559 at pages 569- 570."
Again
in Commissioner of Income-Tax vs. Saran Engineering Co. Ltd. (supra), dealing
with the question as to whether bad and doubtful debts will constitute a
'provision' or 'reserve', the Court stated, thus:- "Bad and Dountful Debts
Reserve was created in 1956 through the Profit and Loss Appropriation account.
The amount involved was Rs. 50,00,000. It was submitted on behalf of the assessee
by Shri Salve that this was created by transfer from the appropriation account
and not as a charge against profit. Furthermore, a separate provision was made
for bad and doubtful debts which provision was reduced from the value of the
assets. It was ;not the Revenue's case that the provision for bad and doubtful
debts provided was less that the amoun reasonably necessary to be provided in
respect of bad and doubtful debts, then it constituted a "reserve".
It is not correct to state that by the very nomenclature, this was not a
reserve. The true nature of the transaction has to be examined." (emphasis
supplied) And again at p. 748 the Court concluded, thus:- "It may be
mentioned that where the liability has actually or is anticipated leqitimately
by the assessee though the quantum of the liability has not been determined, a
fund to meet such present liability cannot be treated as "reserves".
A fund, however, created for payment of a liability which had not alreads
arisen or fallen due but is only a provision with regard to the sum that might
become liable to be paid is "other reserves" within the meaning of
rule 1 of the Second Schedule and should be taken into account in computing the
capital of the company for the purpose of the Companies (Profits) Surtax Act,
1964." (emphasis supplied)
12. A
fair reading of the above decisions would go to show that if the transfer of
amount is made ad hoc, when there is no known or anticipated liability, such
fund will only be treated as 'reserve'. In this case, substantial amounts were
set apart as reserves No amount of bad debt was actually written off or
adjusted against the amount claimed as reserves. No claim for any deduction by
way of bad debts were made during the relevant assessment years. The assessee
never appropriated any amount against any bad and doubtful debts. The amounts
throughout remained in the account of the assessee by way of capital and the assessee
treated the said amounts as "reserves" and not as
"provisions" designed to meet liability, contingency, commitment or
diminution in the value of assets known to exist at the relevant dates of
balance sheets. These facts have been found by the Tribunal.
On the
facts, the amount set apart as reserves cannot be said to be so earmarked, when
ans liability has actually arisen or was anticipated by the assessee. It cannot
be said either, that the amounts set apart out of the profits were designed to
meet any known liability, that exiisted at the date of the balance-sheet.
Tested in the light of the decisions of this Court, referred to hereinabove, it
appears to us, that the amounts set apart towards bad and doubtful debts in
these cases are "reserves" qualifying for appropriate relief under
rule l(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of
the Act.
13. We
are afraid that the High Court has grossly misunderstood the following
observations of this Court contained in Commisioner of Income-Tax vs. Saran
Engineering Co. Ltd. (161 ITR 741) at p. 748.
"It
may be mentioned that where the liability has actually arisen or is anticipated
leigitimately by the assessee though the quantum of the liability has not been dstermined,
a fund to meet such present liability cannot be treated as
"reserves"." (emphasis supplied)
14.
The High Court has taken the view that the "fund created or a sum of money
set apart to meet any liability which the assessee "can reasonably and
legitimately anticipate " on the date of preparation of the balance sheet,
is the same, as in a case "where the liability has actually arisen",
(a present known liability) and the fund to meet such liability cannot be
treated as reserve". In the view of the High Court, since the assessee is
a banking company, it would be "reasonable and leqitimate to assume"
that in the course of its business, "it is bound to have" bad and
doubtful debts for which "it may", in anticipation, make a provision
in the balance sheet by having a separate fund or an account to meet such
anticipated liability We are afraid that the aforesaid assumption is totaily
unjustified and proceeds on mere surmises and conjectures. This is not a case,
when at the time fund is earmarked, there is a known liability one which has
either arisen or anticipated legitimately, by the assessee - and the fund to
meet such eventuality cannot be treated as "reserves". The
observations of this Court that the liability should be one "which has
actually arisen or is anticipated leqitimately by the assessee", cannot be
extended to hold, that in the case of an assessee carrying on banking business,
it is "bound" or "can reasonably anticipate" on the date of
the preparation of balance sheet "bad and doubtful debts", for which
"it ought", in anticipation, make a provision and such provision for
anticipated liability should be equafied with known and existing liability and
should be construed as a provision.
The
question in such cases, is whether the liability was "known" or
"anticipated" on the date when the balance sheet was prepared. The
question is not whether the assessee "can anticipate" or
"reasonably anticipate" on the date when the balance sheet was
prepared about "the bad and doubtful debts". The High Court was in
error in surmising that the assessee being a banking company is bound to have
bad and doubtful debts. It need not necessarily be so. It is not bound to
anticipate on the date of preparation of balance sheet that all or any of its
debts "are bound to be bad and doubtful". It all depends upon facts
and circumstances. We are of the view that the High Court misunderstood the
scope of the observations in Saran Engineering Co.'s case (supra) and surmised
that the observations quoted at page 748 wili even cover cases, where the liability
was not factually anticipated on the date of the preparation of the balance
sheet, but also will apply to cases, where the company "ought and
can" anticipate on the date of preparation of the balance sheet.
14. We
set aside the judgment of the High Court, rendered in ITR No. 235-238 of 1990
dated 27.7.1992 and restore the order passed by the Appellate Txibunal dated
23.1.1980. We answer the questions, referred to the High Court, in the
affirmative, in favour of the assessee and against the Revenue.
15. It
was agreed that the decision taken in special leave petitions Nos. 2392-95/93
for the assessment years 1971-72, 1972-73, 1973-74 and 1975-76 will cover the
other cases as well. Therefore, we hold that the assessee is entitled to the
appropriate relief for the years 1979-80 to 1987-88 as well, which are covered
by the other two sets of appeals.
16.
The appeals are allowed. There shall be no order as to costs.
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