Commissioner
of Income Tax, Trivandrum Vs. M/S. Tranvancore Titanium
Products Ltd. [2000] INSC 630 (7 December 2000)
Y.K.Sabharwal,
D.P.Mohapatro, S.P.Bharucha
L.I.T.J
Y.K.Sabharwal,
J.
This
appeal has been filed by the revenue to challenge the correctness of the
judgment and order of the High Court of Kerala dated 18th August, 1998. The case relates to assessment
year 1985-86. On reference under Section 256(1) of the Income Tax Act, 1961 as
applied to surtax by Section 18 of the Companies (Profits) Surtax Act, 1964 the
questions that arose for consideration of the High Court were:
"(a)
Whether, on the facts and in the circumstances of the case, the Appellate
Tribunal is right in law in holding that the loan redemption reserve amount to
Rs.1 crore is a reserve and not a provision and is to be included in the
computation of capital for the purpose of surtax? (b) Whether, on the facts and
in the circumstances of the case and in view of the Supreme Court decision in
the case of Vazir Sultan Tobacco Co.Ltd. (132 ITR 559), the Appellate Tribunal
is right in holding so?" By the impugned judgment the High Court answered
the questions in the affirmative, that is, in favour of the respondent-assessee
and against the revenue.
The
respondent had obtained Rs.491 lakhs as loan from Government of Kerala from
1968 to 1983 for the expansion of the Titanium Dioxide Plant. It could repay
upto March, 1987 only a sum of Rs.115.50 lakhs. The balance of the loan
outstanding as on 31st
March, 1987 was
Rs.377.50 lakhs which included a sum of Rs.245 lakhs being overdue instalment
of principal from 1983 onwards. Out of the sum of Rs.245 lakhs outstanding, two
instalments totalling Rs.102 lakhs were repaid to the Government during June
1987 and the arrears due to the Government towards principal of the loan amount
as on the date of the presentation of the annual report of the company for the
financial year 1986-87 was Rs.143 lakhs.
The
assessing authority disallowed the sum of Rs.1 crore standing in the credit
side under the head `loan redemption reserve' holding that even if it is
conceded that it is an appropriation from profit by way of a fund even then it
partakes the nature of the `sinking fund' only which can be only for clearing
of an ascertained liability. It further held that the fact that a sum has been
set apart for redeeming liabilities makes it obvious that the intention is for
clearing a liability and not acquiring an asset. The assessing authority held
the amount was a `provision' and not a `reserve. The appeal preferred by the
respondent was dismissed on 31st January, 1990 and the assessment order was upheld by the Commissioner of Income-tax
(Appeals). The Income-tax Appellate Tribunal, however, by order dated 25th
September, 1991 allowed the appeal of the assessee and directed the assessing
officer to include the sum of Rs. 1 crore in the capital of the company for the
purpose of surtax. The Tribunal held that there was no stipulation by the
Government for the creation of loan redemption reserve;
on its
own volition the assessee had been creating a loan redemption reserve by making
an appropriation of profit of Rs.10 lakhs each year beginning from 1970; the
total reserve amount to Rs.100 lakhs remained undisturbed till the year 1987
and in the year 1988 the same was transferred to the general reserve and that
the amount appropriated was not against the profits but was from out of the
profit and the loan redemption reserve did not bring into existence any fresh
liability because the liability was already in existence. These are the
circumstances under which the two questions noticed above were answered by the
High Court in favour of the respondent-assessee.
The
point for determination is whether the loan redemption reserve amount to Rs.1 crore
is a reserve or it is a `provision'. It may be noticed that the tribunal in its
order had also relied upon the decision of the Calcutta High Court in C.I.T. v.
Pieco Electronics & Electricals ([1987] 166 ITR 299). That decision has
also been referred in the impugned judgment of the High Court. The decision of
the Calcutta High Court in Pieco Electronics (supra) has been overturned by
this Court in National Rayon Corporation Ltd. v. Commissioner of Income-tax
([1997] 227 ITR 764).
Relying
upon Vazir Sultan Tobacco Co. Ltd. v.
Commissioner
of Income-tax, A.P. ([1981] 132 ITR 559) the Court rejected the contention that
if the redemption or appropriation of a sum out of profits and surpluses was
for a unknown liability or for a liability which did not exist on the relevant
date, it must be regarded as a reserve. The contention was held to be
fallacious. The expressions `provision' and `reserve' have not been defined in
the Companies (Profits) Surtax Act, 1964. After referring to the dictionary meaning
of these expressions and bearing in mind the distinction between the two
concepts as known in the commercial accountancy and decision of this Court in
C.I.T. v. Century Spinning & Manufacturing Co.Ltd.
([1953]
24 ITR 499) and Metal Box Company of India Ltd. v.
Their
Workmen ([1969] 73 ITR 53) it was held in Vazir Sultan's case (supra):
"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. Bearing in mind the aforesaid broad distinction we
will briefly indicate how the two concepts are defined and dealt with by the
Companies Act, 1956.
Under
s.210 of the Companies Act, 1956, it is incumbent upon the board of directors
of every company to law before the annual general meeting of its shareholders,
(a) the annual balance-sheet, and (b) the profit and loss account pertaining to
the previous financial year. Section 211 (1) provides that every balance-sheet
of a company shall give a true and fair view of the state of affairs of the
company as at the end of the financial year and shall, subject to the
provisions of this section, be in the form set out in Pt. I of Sch. VI, or near
thereto as circumstances admit or in such other form as may be approved by the
Central Govt. either generally or in any particular case, while s. 211 (2)
provides that every profit and loss account of a company shall give a true and
fair view of the profit or loss of the company for the financial year and
shall, subject as aforesaid, comply with the requirements of Pat. II of Sch.
VI, so far as they are applicable thereto.
In
other words the preparation of balance-sheet as well as profit and loss account
in the prescribed forms and laying the same before the shareholders at the
annual general meeting are statutory requirements which the company has to observe.
The form of balance-sheet as given in Pt. I of Sch. VI contains separate heads
of "Reserves and Surpluses" and "Current Liabilities and
Provisions" and under the sub-head "Reserves" different kinds of
reserves are indicated and under sub-head "Provisions" different
types of provisions are indicated! Part III is the interpretation clause
setting out the definitions of various expressions occurring in Pts I and II
and the expressions "reserve", "provision" and
"liability" have been defined in cl.7 thereof. Material portion of
cl.7 of Pt.III runs as under:
`(1)
For the purposes of Parts I and II of this Schedule, unless the context
otherwise requires,- (a) the expression `provisions' shall, subject to
sub-clause (2) of this clause, mean any amount written off or retained by way
of providing for depreciation, renewals or diminution in value of assets, or
retained by way of providing for any known liability of which the amount cannot
be determined with substantial accuracy;
(b)
the expression `reserve' shall not, subject as aforesaid, include any amount
written off or retained by way of providing for depreciation, renewals or
diminution in value of assets or retained by way of providing for any known
liability; ........ and in this sub-clause the expression `liability' shall
include all liabilities in respect of expenditure contracted for an all
disputed or contingent liabilities.
(2)
Where- (a) any amount written off or retained by way of providing for
depreciation renewals or diminution in value of assets, not being an amount
written off in relation to fixed assets before the commencement of this Act; or
(b) any amount retained by way of providing for any known liability; is in
excess of the amount which in the opinion of the directors, is reasonably
necessary for the purpose, the excess shall be treated for the purposes of this
Schedule as a `reserve' and not a `provision'.
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 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.
We are
emphasising this aspect of the matter because during the hearing almost all
counsel for the assesses 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 the
proper approach in our view would be first to ascertain whether the particular
retention or appropriation of a sum falls 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 defined, 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." In view of the aforestated legal
position, the aspects taken into consideration by the tribunal and affirmed by
the High Court that there was no stipulation by the Government for creation of
loan redemption reserve; that the assessee had not kept to the schedule for
repayment; that the assessee, on its own volition, had created a loan
redemption reserve by making appropriation of profit of Rs.10 lakhs each year
beginning from 1970; that the total reserve amounting to Rs.100 lakhs remained
undisturbed till the year 1987 and in the year 1988 the same was transferred to
general reserve and that the balance sheet showed that the amounts credited to
the `loan redemption reserve' were not invested outside the company but
remained internally invested, on the facts found, were not relevant for
determining as to whether the amount was an asset or provision. As held in Vazir
Sultan the true nature and character of an appropriation has to be determined
with reference to the substance of the matter, one must have regard to the
intention with which and the purpose for which the appropriation has been made,
such intention and purpose being gathered from the surrounding circumstances.
The Vazir Sultan's case (supra) also holds 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 fallow that if the retention or appropriation is
not a `provision' it is automatically a reserve. The fact that amount has been
set apart for redeeming liabilities makes it obvious that the intention is for
clearing liabilities and not acquiring an asset. Bearing in mind these aspects,
it is clear that the amount in question cannot be regarded as a `reserve'. It
has to be regarded as a `provision'. Clearly the amount was set apart to meet a
loan liability. It may also be noticed that the amount set apart is less than
the respondent's liabilities. It cannot be regarded as an asset. The decision
in Vazir Sultan's case (supra) was not correctly appreciated by the High Court.
In this view, the questions deserve to be answered in the negative.
For
the aforesaid reasons, we allow the appeal and answer the questions in the
negative, that is, in favour of the revenue and against the assessee, upholding
the order of the assessing authority. The parties are left to bear their own
costs.
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