JUDGMENT
Suhas Chandra Sen, J.
1. The Tribunal has referred the following question of law under Section 256(2) of the Income-tax Act, 1961, to this court :
“Whether, on the facts and in the circumstances of the case, the Tribunal was right in fact and in law in holding that the provision for leave pay liability should be treated as ‘reserve’ for the purpose of computation of capital under the provisions of the Companies (Profits) Surtax Act, 1964?”
2. The assessment years involved are 1982-83, 1983-84 and 1984-85, for which the corresponding previous years were the financial years 1981-82, 1982-83 and 1983-84.
3. The facts as stated by the Tribunal in the statement of facts were as under :
The Assessing Officer in the course of assessment, while computing “capital” relevant to the respective surtax assessment, did not consider leave pay liability as “reserve” inasmuch as this liability was provided for meeting a known liability arising in future and, as such, it was only a provision and not a reserve.
4. Being aggrieved, the assessee went up in appeal before the Commissioner of Income-tax (Appeals), and urged that in income-tax assessment, provision for leave salary was disallowed on the ground that the liability concerned was of the nature of contingent liability and could not be considered to have arisen exactly. Therefore, in surtax assessment, the amount representing such liability should be treated as reserve. The assessee in support of the contention relied on the decision of the Supreme Court in the case of CIT v. Saran Engineering Co. Ltd. [1986] 161 ITR 741.
5. The Commissioner of Income-tax (Appeals), however, to arrive at the distinction between “provision” and “reserve”, relied on the decisions of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. v. CIT , Metal Box Co. of India Ltd. v. Their Workmen and CIT v. Elgin Mills Ltd. and viewed that the court held that whereas a “provision” is a charge against the profits to be taken into account against gross receipts in the profit and loss 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. The court also held that merely because a particular liability is not a provision that would not make it a “reserve” automatically. But in the present case, the liability has been anticipated legitimately by the assessee and a fund to meet such liability cannot be treated as reserve. The liability has been created by making a debit to the operating (sic) account and not by way of appropriation or charge on the profits. Thus, the Commissioner of Income-tax (Appeals) confirmed the order of the Assessing Officer.
6. Being aggrieved, the assessee came up in appeal before the Tribunal. The Tribunal considering the nature of the claim and arguments advanced by the assessee, was of the opinion that the assessee deserves to succeed. The Tribunal relied on the decision of the Supreme Court in the case of CIT v. Laxmi Sugar and Oil Mills Ltd, [1986] 161 ITR 168 and of the Calcutta High Court in the cases of CIT v. Bharat General and Textile Industries Ltd. [1986] 157 ITR 159 and CIT v. Shaw Wallace and Co. Ltd. [1987] 167 ITR 27 and found that the decisions in the abovementioned cases squarely cover the issue under consideration and are directly applicable to the facts, of the instant case. The Tribunal also found from the annual report of the assessee for 1986-87 that it wrote back to the profit and loss account the provision for leave salary for previous years as “unspent liability no longer required” and the assessee discontinued the practice of providing for unavailed leave. In the conclusion, the Tribunal allowed the assessee’s appeal and reversed the order of the Commissioner of Income-tax (Appeals) on this point.
7. Elaborate arguments had been advanced by Mr. R.N. Bajoria, on behalf of the assessee, and Mr. S.L. Saraf, on behalf of the Revenue, to establish the true nature of the assessee’s liability for “leave pay”. A large number of cases were relied upon by both sides in support of their contentions.
8. The Companies (Profits) Surtax Act, 1964, has imposed tax on companies in respect of “so much of its chargeable profits of the previous year or previous years, as the case may be, as exceeds the statutory deduction, at the rate or rates specified in the Third Schedule”. “Chargeable profits” has been defined by Section 2(5) of the Act to mean “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”.
9. The Second Schedule to the Act contains rules for computing the capital of a company for the purpose of surtax. Rules 1 and 4A are important for the purposes of this case and are as under :
“1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year of,–
(i) its paid-up share capital ;
(ii) its reserves, if any, created under the proviso (b) to Clause (vib) of Sub-section (2) of Section 10 of the Indian Income-tax Act, 1922, or under Sub-section (4) of Section 32A or Sub-section (3) of Section 34 of the Income-tax Act, 1961 ;
(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.”
“1A. Where a company has not made any credit in any account in its books as on the first day of the previous year relevant to the assessment year which is of the nature of item (8) or item (9) 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, or where the Income-tax Officer is of the opinion that the amount credited in such account falls short of the amount which should have reasonably been credited by it, the amount of its capital as computed under Rule 1 shall be reduced by the amount which has not been so credited or, as the case may be, the amount of such shortfall.”
10. In the case of CIT v. Laxmi Sugar and Oil Mills Ltd. , the Supreme Court held that an amount set apart as provision for
additional cane price payable to cane growers under a price link formula to be fixed by the competent authority under the Sugarcane Price Control Order, 1955, was a “reserve” and not a “provision”. The Supreme Court took note of the fact that no payment was ever actually made by the assessee and in the relevant accounting year, the assessee credited its profits by the sum of Rs. 8,16,000 by reversing the entries earlier made. It was held by the Supreme Court that since there was no liability at all on the respondent requiring it to set apart a sum as a charge against its profits and there was never any intention to make payments to the cane growers nor was any payment ever made, the amount had to be treated as “reserve”. The Supreme Court attached great importance to the fact that the entry had been actually reversed by the assessee himself in their relevant yearly account.
11. In the case of CIT v. Elgin Mitts Ltd. , the Supreme Court reiterated the principles enunciated in the case of Metal Box Co. of India Ltd. v. Their Workmen , and observed (at page 739) :
“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 profit and loss account and the balance-sheet. On the other hand, reserves are appropriation 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 edition, page 42). An amount set aside out of 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-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, Second edition, page 192 ; Part III, clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve).”
12. In the case of CIT v. Peico Electronics and Electricals [1987] 166 ITR 299, the Division Bench of this court held that debenture redemption reserves of a company fulfilled the test of a reserve because the reserve had been created out of appropriation from profits, and not by way of a charge on the revenue. The funds had been retained to form part of the capital employed in the business and none of the debentures became redeemable during the accounting period. The liability to redeem the debentures was future liability. The debenture had been separately shown in the balance-sheet as a liability. Therefore, the Tribunal was right enough in holding the contention of the assessee. The Delhi High Court took a similar view in the case of CIT v. Modi Industries Ltd. (No. 2) [1992] 197 ITR 655. It is held in that case that the debenture redemption fund had been created only for the purpose of setting apart a certain sum of money for use in future. Therefore, the fund could not be treated as provision.
13. Our attention was also drawn to the case of CIT v. Dey’s Medical Stores Ltd. . In that case, it was held (at page 617) :
“…. whether the contingency reserve was a reserve or provision will depend upon the purpose and intention of the assessee for creating such a reserve. If it is to meet a contingency, which is unforeseen and cannot be anticipated, then the amount so set apart as reserve cannot be treated as a provision to meet a known liability. In the instant case, the finding of the Tribunal is that the amount has not been set apart for payment of bonus but the reserve was created to meet an unknown and unforeseen eventuality. This is a case of an amount being set apart to meet an unknown liability which may not arise at all. The assessee as a prudent businessman set apart a certain sum of money to meet an unknown contingency. The amount is to be treated as a reserve and not provision. The balance in the contingency reserve should be taken in computing the capital base of the company in terms of Rule l(iii) of the Second Schedule to the Surtax Act.”
14. In the form of balance-sheet provided in Schedule VI of the Companies Act under the heading of ‘Provisions’ the following items have been mentioned :
“(8) Provision for taxation ;
(9) Proposed dividends ;
(10) For contingencies ;
(11) For provident fund scheme ;
(12) For insurance, pension and similar staff benefit schemes.”
15. It is well-settled that moneys set apart for payment to the staff like gratuity or provident fund are to be treated as provisions. Annual
contributions towards these schemes are allowed as deduction in computation of the income of the assessee.
16. It has been contended on behalf of the assessee that in the instant case, the assessee ultimately did not get any deduction on account of the item shown as “provision for leave salary”. The assessee, however, did not pursue the matter before the higher authorities or the court. On a reference, it cannot be inferred from this fact that the amount which was disallowed as deduction according to the Income-tax Act must be treated as “reserve” under the provisions of the Companies (Profits) Surtax Act, 1964. The obligation to pay leave salary is a statutory liability created by Section 79 of the Factories Act. Every worker who has worked for a period of 240 days or more in a factory must be allowed leave with wages for a number of days calculated at the prescribed rate. If a worker does not take the entire leave due to him in any one calendar year, any leave not taken by him shall be added to his leave entitlement to the subsequent calendar year. If the employment of the Worker is terminated before he takes the entire leave due to him or if the worker retires prematurely, the worker will be entitled to be paid for the period during which the leave entitlement was not availed of.
17. Section 80 lays down the quantum of wage that a worker must be paid during the leave period. The unpaid wages of the leave period will be recoverable under the provisions of the Payment of Wages Act, 1936.
18. In the instant case, the company was under ah obligation to pay leave wages to the workman. Any amount whether the workers availed bf the entire amount of wages in one calendar year or not is immaterial for the purpose of the case. This is a liability imposed upon the company by the statute. Therefore, any amount set apart for meeting this liability must be treated as “provision” and not “reserve”.
19. In that view of the matter, the question referred by the Tribunal is answered in the negative and in favour of the Revenue.
20. There will be no order as to costs.
21. Since Justice Suhas Chandra Sen has been elevated to the Bench of the Supreme Court of India, this file cannot be placed before his Lordship for signature.
Arun kumar Dutta, J.
22. I agree.