Commissioner of Income-Tax, Bombay
City Vs. The Century Spinning And Manufacturing Co. Ltd. [1953] INSC 57 (8
October 1953)
HASAN, GHULAM SASTRI, M. PATANJALI (CJ) DAS,
SUDHI RANJAN BOSE, VIVIAN BHAGWATI, NATWARLAL H.
CITATION: 1953 AIR 501 1954 SCR 203
CITATOR INFO :
R 1961 SC 812 (5,11) RF 1966 SC1393
(13,16,23) R 1981 SC2105 (8,26,37,40,41,43,46)
ACT:
Business Profits Tax Act (XXI of 1947), Sch.
II, rr. 2 and 3--Determination of capital of company-Inclusion of `reserves'-Accumulated
profit carried over to next year without declaring it as reserve-Whether
'reserve'-Indian Companies Act (VII of 1913), ss. 131-A, 132, Sch. I, Table A,
Reg. 99.
HEADNOTE:
The balance sheet of a company for the
calendar year 1945 showed a profit of Rs. 90,44,677, subject to the provision
for depreciation and taxation, and, after giving credit to these items 204 the
balance of Rs. 5,08,637 was carried to the balance sheet of the next year on
the 1st January, 1946, without making or declaring it a reserve. On the 28th February, 1946, the directors marked it for distribution as dividend, on the 3rd
April, a resolution was passed for distributing it as dividend, and a few days,
later it was actually distributed as dividend:
Held, that as the said sum of Rs. 5,08,637
was never earmarked or declared as a reserve, but was, on the other hand,
earmarked for distribution as dividend on the 28th February and 3rd April and
was actually so distributed, it cannot be deemed to be a reserve and added to
the paid-up capital in determining the company's capital under rr. 2 and 3 of
Sch. II to the Business Profits Tax Act, 1947, for the chargeable accounting
period commencing on the 1st April, 1946.
Held also, that the profits of the company
from the 1st January to 1st April, 1946, cannot also be treated as reserves.
CIVIL APPELLATE JURISDICTION -. Civil Appeals
Nos. 157 and 158 of 1952.
Appeals from the Judgment and Order dated the
29th day of March, 1951, of the High Court of Judicature at Bombay (Chagla C.J.
and Tendolkar J.) in its Original Civil Jurisdiction in Income-tax Reference
No. 27 of 1950.
G.N. Joshi for the Commissioner of
Income-tax.
R.J. Kolah for the Century Spinning and
Manufacturing Co. Ltd.
1953. October 8. The Judgment of the Court
was delivered by GHULAM HASAN J. These two connected appeals, one by the
Commissioner of Income-tax, Bombay, and the other by the Century Spinning &
Manufacturing Co. Ltd., arise out of the judgment and order of the Bombay High
Court delivered on a reference made by the Income-tax Appellate Tribunal,
Bombay.
The two questions of law referred by the
Tribunal were as follows:(1) Whether the amount of Rs. 5,08,637 is a part of
the reserves' of the assessee company as on 1st April, 1946, within the meaning
of rule 2(1) of the rules in Schedule II to the Business Profits, Tax Act, and
205 (2) Whether the profits of them assessee company from 1st January to 1st
April, 1946, should be included in the said reserves as on 1st April, 1946.
The High Court answered the first question in
the affirmative and the second in the negative.
The accounting year followed by the assessee
is the calendar year and the chargeable accounting period is the 1st of April,
1946, to the 31st of December, 1946, in respect of the profits ending with 31st
December, 1945. The profits according to the profit and loss account were Rs.
90,44,677 subject to the provisions for depreciation and taxation.
After making provisions for these, the
balance of Rs. 5,08,637 was carried to the balance-sheet.
Two contentions were raised on behalf of the
assessee before the Income-tax Officer, the first being whether the aforesaid
sum could be called a "reserve" within the meaning of rule 2(1) of
the Rules in Schedule II to the Business Profits Tax Act and whether it should
be included in its reserves while determining the capital on the 1st April,
1946; the second that the proportionate profits of the assessee for three
months, between the 1st January, 1946, and the 1st April, 1946, should also be
included in the said reserves. The Income-tax Officer rejected the contention
holding that "A 'reserve' represents profits set apart for some specific
or general purpose and therefore profits which have not been so set apart
cannot be treated as forming part of reserves for the purpose of inclusion in
the capital." This order was confirmed on appeal by the Appellate
Assistant Commissioner but was set aside by the Income-tax Appellate Tribunal.
Thereupon the Tribunal formulated the two questions aforementioned for reference
to the High Court under section 66(1) of the Act, read with section 19 of the
Business Profits Tax Act of 1947. As already stated the High Court decided the
first question in favour of the assessee and the second in favour of the
department. Hence the two appeals.
The Business Profits Tax Act (No. XXI of
1947) came into force on the 11th April, 1947, having taken 28 206 the place of
the Excess Profits Tax Act which was repealed on the 30th March, 1946. This
Act, as is we] I known, was designed to assess large profits made by companies
carrying on business during the boom years of the war. It was revived, as it
were, after a year in the shape of the present Act, though in a modified form.
Section 4 Which is the charging section, so far as it is material for our
purposes, permits the levying on the amount of the "taxable profits"
during any "chargeable accounting period", a tax called the
"business profits tax" which shall be equal to sixteen and two-thirds
per cent of the taxable profits.
"Taxable profits" means the amount
by which the profits during a chargeable accounting period exceed the abatement
in respect of that period [section 2(17)]. "Abatement", according to
section 2 (1) means, in respect of any chargeable accounting period ending on
or before the 31st day of March, 1947, a sum which bears to a sum equal to"(a)
in the case of a company, not being a company deemed for the purposes of
section 9 to be a firm, six per cent. of the capital of the company on the
first day of the said period computed in accordance with Schedule II, or one
lakh of rupees, whichever is greater.........the same proportion as the said
period bears to the period of one year .........." "Accounting
period" according to section 2(2) in relation to any business means any
period which is or has been determined as the previous year for that business
for the purposes of the Indian Income-tax Act, 1922. Lastly "chargeable
accounting period" is defined in section 2(4) as follows:"(a) any
accounting period falling wholly within the terms beginning on the first day of
April, 1946, and ending on the thirty-first day of March ;
(b) where any accounting period falls partly
within and partly without the said term, such part of that accounting period as
falls within the said term:".
It appears that the definition of abatement
contemplates that the normal profit of a company is six per cent, on its
capital and where the, profit exceeds 207 that amount, it becomes liable to pay
business profits tax.
Schedule 11 lays down the rule for computing
the capital of a company for purposes of business profits tax and rule 2(1) of
the Schedule which admittedly applies to the present case lays down that
"Where the company is one to which rule 3 of Schedule I applies, its
capital shall be the sum of the amounts of its paid-up share capital and of its
reserves in so far as they have not been allowed in computing the profits of
the company for the purposes of the Indian Income-tax Act.........." The
point that arises for consideration on the first question is whether the
assessee is entitled to treat the sum of Rs. 5,08,637 as a reserve and to add
it to its paidup share capital for the purposes of computing the abatement. Two
essential characteristics must be present before the assessee can avail himself
of the benefit of the rule, namely, that the amount should not have been
allowed in computing the profits of the company for the purposes of Income-tax
Act and that it should be a reserve as contemplated by the rule. That it has
not been so allowed is not denied and therefore the only question is whether it
can be treated as a reserve within the meaning of the rule. The balance-sheet
shows that the company made a profit of Rs. 90,44,677 for the calendar year
1945 subject to the provision of depreciation and taxation. After giving credit
for these items the balance of Rs. 5,08,637 was carried to the balance-sheet on
1st January, 1946, in the profit and loss account. On the 28th February, 1946,
the directors recommended that the aforesaid sum should be appropriated in the
following manner: -Payment of a final dividend at the rate of Rs. 18 per share
(making Rs. 28 per share for the whole year) free of income-tax absorbing...
Rs. 4,92,426-0-0 Balance to be carried forward to next year's account ... Rs. 16,211-6-8
This recommendation was accepted by the shareholders in their meeting on the
3rd April, 1946, by a resolution passed to that effect. The dividend was made
payable on the 15th April, 1946, and it is not 208 denied that it was actually
distributed. These being the facts, the question arises whether the amount in
question can be called a "reserve".
The term "reserve" is not defined
in the Act and we must resort to the ordinary natural meaning as understood in
common parlance. The dictionary meaning of the word "Reserve" is :"
1(a) To keep for future use or enjoyment; to store up for some time or
occasion; to refrain from using or enjoying at once.
(b) To keep back or hold over to a later time
or place or other further treatment.
6. To set apart for some purpose or with some
end in view; to keep for some use.
11.To retain or preserve for certain
purposes." (Oxford Dictionary, Vol. VIII, p. 513).
In Webster's New International Dictionary,
Second Edition, page 2118, "Reserve" is defined as follows:
"1. To keep in store for future or
special use; to keep in reserve; to retain, to keep, as for oneself.
2.To keep back; to retain or hold over to a
future time or place.
3. To preserve." What is the true nature
and character of the disputed sum, must be determined with reference to the
substance of the matter and when this is borne in mind, it follows that on the
1st of April, 1946, which is the crucial date, the sum of Rs. 5,08,637 could
not be called a "reserve", for nobody possessed of the requisite authority
had indicated on that date the manner of its disposal or destination. On the
other hand, on the 28th February, 1946, the directors clearly ear-marked it for
distribution as dividend and did not choose to make it a reserve. Nor did the
company in its meeting on the 3rd April, 1946, decide that it was a reserve. It
remained on the 1st of April as a mass of undistributed profits which were
available for distribution and not ear-marked as "reserve". On the
1st of January, 1946, the amount was simply brought from 209 the profit and
loss account to the next year and nobody with any authority on that date made
or declared a reserve. The reserve may be a general reserve or a specific
reserve, but there must be a clear indication to show whether it was a reserve
either of the one or the other kind. The fact that it constituted a mass of
undistributed profits on the 1st January, 1946, cannot automatically make it a
reserve. On the 1st April, 1946, which is the commencement of the chargeable
accounting period, there was merely a recommendation, by the directors that the
amount in question should be distributed as dividend. Far from showing that the
directors had made the amount in question a reserve, it shows that they had
decided to ear-mark it for distribution as dividend. By the resolution of the
shareholders on the 3rd April, 1946, the amount was shortly afterwards
distributed as dividend. The High Court appear to have been under a
misapprehension as to the real position, for they observed :-"It was open
to the directors to distribute the sum of Rs. 5,08,537 as dividends. They did
not choose to do so and have kept back this amount. Therefore, by keeping back
this amount they constituted it a reserve. A reserve in the sense in which it
is used in rule 2 can only mean profit earned by a company and not distributed
as dividend to the shareholders but kept back by the directors for any purpose
to which it may be put in future. Therefore, giving to the 'reserves' its plain
natural meaning, it is clear that the sum of Rs. 5,08,637 was kept in reserve
by the company and not distributed as profits and subjected to taxation.
Therefore, it satisfied all the requirements of rule 2." The directors had
no power to distribute the sum as dividend. They could only recommend, as
indeed they did, and it was up to the shareholders of the company to accept
that recommendation in which case alone the distribution could take place. The
recommendation was accepted and the dividend was actually distributed. It is,
therefore, not correct to say that the amount was kept back. The nature of the
amount which was nothing more than the undistributed profits of the company,
remained unaltered. Thus the profits lying unutilized and not 210 specially set
a part for any purpose on the crucial date did not constitute reserves within
the meaning of' Schedule II, rule 2 (1).
Reference was made to sections 131 (a) and
132 of the Indian Companies Act. Section 131 (a) enjoins upon the directors to
attach to every balance-sheet a report with respect to the state of company's
affairs and the amount if any which they recommend to be paid by way of
dividend and the amount, if any, which they propose to carry to the Reserve
Fund, General Reserve or Reserve Account. The latter section refers to the
contents of the balance-sheet which is to be drawn up in the Form marked F in
Schedule III. This Form contains a separate head of reserves.
Regulation 99 of the First Schedule, Table A,
lays down "that the directors may, before recommending any dividend set
aside out of the profits of the company such sum as they think proper as a
reserve or reserves which shall, at the discretion of the directors, be
applicable for meeting contingencies, or for equalising dividends, or for any
other purpose to which the profits of the company may be properly
applied......... The Regulation suggests that any sum out of the profits of the
company which is to be made as a reserve or reserves must be set aside before
the directors recommend any dividend. In this case the directors while
recommending dividend took no action to set aside any portion of this sum as a
reserve or reserves. Indeed they never applied their mind to this aspect of the
matter. The balance-sheet drawn up by the assessee as showing the profits was
prepared in accordance with the provisions of the Indian Companies Act.
These provisions also support the conclusion
as to what is the true nature of a reserve shown in a balance-sheet.
We are, of the opinion that the view taken'
by the Bombay High Court is erroneous and must be set aside. The appeal of the
Commissioner of Income-tax is allowed with costs.
As regards the second question, Mr. Kolah the
learned counsel for the company, frankly conceded that the view taken by the
High Court on this part of the case is not open to challenge and is correct.
The 211 High Court held that the profits for three months from the 1st January, 1946, to the 1st April, 1946, were not reserves which would attract the
application of rule 2 of Schedule
11. With this conclusion we agree. The
assessee's appeal is, therefore, dismissed with costs.
Appeal No. 157 allowed.
Appeal No. 158 dismissed.
Agent for the Commissioner of Income-tax: G.
H. Rajadhyaksha.
Agent for the company: I. N. Shroff.
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