{"id":48844,"date":"1981-09-25T00:00:00","date_gmt":"1981-09-24T18:30:00","guid":{"rendered":"https:\/\/www.legalindia.com\/judgments\/vazir-sultan-tobacco-co-ltd-etc-vs-commlssioner-of-income-tax-on-25-september-1981"},"modified":"2018-12-29T00:47:24","modified_gmt":"2018-12-28T19:17:24","slug":"vazir-sultan-tobacco-co-ltd-etc-vs-commlssioner-of-income-tax-on-25-september-1981","status":"publish","type":"post","link":"https:\/\/www.legalindia.com\/judgments\/vazir-sultan-tobacco-co-ltd-etc-vs-commlssioner-of-income-tax-on-25-september-1981","title":{"rendered":"Vazir Sultan Tobacco Co. Ltd. Etc. … vs Commlssioner Of Income-Tax … on 25 September, 1981"},"content":{"rendered":"
Supreme Court of India<\/div>\n
Vazir Sultan Tobacco Co. Ltd. Etc. … vs Commlssioner Of Income-Tax … on 25 September, 1981<\/div>\n
Equivalent citations: 1981 AIR 2105, \t\t 1982 SCR (1) 789<\/div>\n
Author: V Tulzapurkar<\/div>\n
Bench: Tulzapurkar, V.D.<\/div>\n
           PETITIONER:\nVAZIR SULTAN TOBACCO CO. LTD. ETC. ETC.\n\n\tVs.\n\nRESPONDENT:\nCOMMlSSIONER OF INCOME-TAX ANDHRA PRADESH, HYDERABAD\n\nDATE OF JUDGMENT25\/09\/1981\n\nBENCH:\nTULZAPURKAR, V.D.\nBENCH:\nTULZAPURKAR, V.D.\nVENKATARAMIAH, E.S. (J)\nSEN, AMARENDRA NATH (J)\n\nCITATION:\n 1981 AIR 2105\t\t  1982 SCR  (1) 789\n 1981 SCC  (4) 435\t  1981 SCALE  (3)1483\n CITATOR INFO :\n RF\t    1986 SC 484\t (13,17)\n F\t    1986 SC1746\t (6)\n R\t    1986 SC1938\t (5,13,14,16,17)\n\n\nACT:\n     Super Profits  Tax Act,  1963 and\tCompany's  (Profits)\nSur-tax\t Act,  1964-Rule  I  of\t Second\t Schedule-Scope\t of-\n\"Provision\"  and   \"Reserve\"-Distinction-  A  sum  of  money\ntransferred  from   current  profits  to  general  reserves-\nDividend paid from that fund-General reserve how calculated.\n\n\n\nHEADNOTE:\n     The Super\t(Profits Tax)  Act, 1963  and the  Company's\n(Profits) Sur-tax  Act, 1964 (the scheme and main provisions\nof both\t of which are almost identical) impose a special tax\non excess  profits earned  by companies.  The special tax is\nimposed in  respect of\tso much\t of a  company's \"chargeable\nprofits\" of  the previous  year as  exceeded  the  \"standard\ndeduction\"- The\t term \"chargeable profit\" is defined to mean\nthe total  income of  an assessee  computed under the Income\nTax  Act,  1961\t for  any  previous  year  and\tadjusted  in\naccordance  with  the  provisions  of  that  Act.  \"Standard\ndeduction\" is  determined by  computing\t the  capital  of  a\ncompany in  accordance with  the  rules\t laid  down  in\t the\nschedule. The  material part  of rule I provides that before\nany  amount  or\t sum  qualifies\t for  inclusion\t in  capital\ncomputation of\ta company  two conditions are required to be\nfulfilled namely:  (i) that  the amount\t or sum\t must  be  a\n\"reserve\" and  (b) that\t it must  not have  been allowed  in\ncomputing the  company's profit\t for the  purposes of Income\nTax Acts, 1922 or 1961.\n     ln their  respective balance  sheets, the assessees had\nshown under the heading \"current liabilities and provisions\"\nappropriations\tof   large  sums   of  money  for  taxation,\nretirement gratuity  and dividends  and claimed that for the\npurposes of  super profits tax these sums should be regarded\nas \"other  reserves\" within  the meaning of Rule 1 of Second\nSchedule to  the Act and that for the computation of capital\nthey should be taken into account.\n     Treating  these   sums  as\t  \"provisions\"\tand  not  as\n\"reserves\", the\t Super Profits\tTax officer  determined\t the\ncapital and  the standard  deduction by\t excluding them from\nthe computation of the capital. He then levied super profits\ntax on\tthat  portion  of  the\tchargeable  profits  of\t the\nprevious year as exceeded the standard deduction.\n     While the\tAppellate Assistant  Commissioner upheld the\nassessee's contention  that these sums were \"reserves\" which\nshould be  taken into  account for  computing their capital,\nthe Appellate  Tribunal held  that these were not \"reserves\"\nwithin\n790\nthe meaning  of Rule l of the Second Schedule to the Act and\nas such could not enter into capital computation.\n     On reference  the High  Court held\t that the  sums\t set\napart were  not \"reserves  and so  should be excluded in the\ncomputation of\tthe capital  for the purposes of levying the\nsuper profits tax.\n     In Tax  Reference no.  5 (a  case under  the  Companies\n(Profits) Sur-tax  Act, 1964)  the assessee transferred from\nout of\tits current  profits a\tlarge sum  of money  to\t the\ngeneral reserves  and paid dividend to its shareholders from\nout of\tthe augmented  general\treserves.  On  the  question\nwhether for computing the capital for the purpose of sur-tax\nthe general  reserves should or should not be reduced by the\nsum  of\t dividend  paid,  the  taxing  authorities  and\t the\nappellate tribunal  ignored this  amount holding that it was\nnot a \"reserve\".\n     None of  the items of appropriation either for taxation\nor for\tretirement gratuity  or for proposed dividend in the\nassessees' cases had been allowed in computing their profits\nunder the Income Tax Act, 1961.\n^\n     HELD: [per Tulzapurkar & Venkataramiah, JJ]\n     The expressions \"reserve\" and \"provision\" have not been\ndefined in  the Act.  Standard dictionaries,  without making\nany distinction\t between the  two concepts, use them more or\nless synonymously  connoting the same idea. But since in the\ncontext of  the legislation  a clear distinction between the\ntwo is implied it is essential to know the exact connotation\nof  the\t two  concepts\tand  the  distinction  as  known  in\ncommercial accountancy. The rules for computation of capital\ncontained in  the Second  Schedule to the Act proceed on the\nbasis of the formula of capital plus reserve, a formula well\nknown in  commercial accountancy.  But since they occur in a\ntaxing\tstatute\t  applicable   to   companies\tonly   these\nexpressions will  have to  be understood  in  the  sense  or\nmeaning attributed  to them  by men  of business,  trade and\ncommerce and  by  persons  interested  in  or  dealing\twith\ncompanies. Therefore, the meaning attached to these words in\nthe Companies  Act, 1956 would govern their construction for\nthe purpose of these two enactments [800 C-H]\n     The broad\tdistinction between  the two  expressions as\njudicially  evolved   by  this\t Court\tis   that,  while  a\n\"provision\" is a charge against the profits to be taken into\naccount against\t gross\treceipts  in  the  profit  and\tloss\naccount, a  \"reserve\" is  an appropriation  of profits,\t the\nasset or assets by which it is represented being retained to\nform part of the capital employed in the business. [801 F]\n     C.l.T. v.\tCcntury Spinning & Manufacturiag Co., 24 ITR\n499 and Metal Box Company of India Ltd. v. Their Workmen,<\/a> 73\nlTR 67 followed.\n     The Companies  Act, which\tenjoins upon  the  Board  of\nDirectors of  every company to lay before the annual general\nmeeting of  its shareholders  an annual\t balance sheet and a\nprofit and  loss account, enumerates the separate heads that\nshould be  shown in  the balance  sheet, two  of these items\nbeing \"reserve'\t and \"provision\".  The definitions  of these\ntwo expressions given in the Act show\n791\nthat if any retention or appropriation of a sum falls within\nthe definition of A \"provision\" it can never be a \"reserve\".\nBut  the   converse  is\t  not  true.  If  the  retention  or\nappropriation is  not a\t \"provision\" that  is, if  it is not\ndesignated to  meet depreciation,  renewals or diminution in\nvalue  of   assets  or\t any  known   liability\t it  is\t not\nautomatically a\t \"reserve\" and\tthe question will have to be\ndecided having\tregard to  the true  nature and character of\nthe sum\t so retained  or appropriated  depending on  several\nfactors, including the intention with which and the purposes\nfor which  such retention  or appropriation  had been  made.\n[803 E-Fl\n     Having regard  to the  type of  definitions of  the two\nconcepts, if  a particular  retention or  appropriation of a\nsum falls  within the  expression \"provision\"  then that sum\nwill have to be excluded from the computation of capital. If\nthe sum\t is in\tfact a \"reserve\" then it would be taken into\naccount for the computation of capital. [804 B-C]\n     Where the assessee had set apart a sum of money to meet\ntax  liability\tin  respect  of\t profits  earned  during  an\naccounting year,  which liability  was not  quantified, such\nsetting apart for a known and existing liability, would be a\n\"provision\" and\t could not  be regarded as a \"reserve\". [806\nA-C]\n     Kesoram Industries and Cotton Mills Ltd.v. Commissioner\nof Wealth Tax  (central) Calcutta, 59 ITR 767 followed.\n     But if  provision for  a known or existing liability is\nmade in\t excess of  the amount\treasonably necessary for the\npurpose, such  excess should  be treated  as  reserve\"\tand,\ntherefore, would  be includible in capital computation. [806\nE]\n     Since the assessee (in C.A. No. 860\/73) had at no stage\nof  the\t  proceedings  before\tthe  Taxing  Authorities  or\nAppellate Tribunal  or the High Court raised a plea that the\nprovision made\tby it  for taxation  was in  excess  of\t the\namount reasonably  necesssary for  the purpose and that such\nexcess should  be treated  as a\t \"reserve\", the\t plea  which\nneeds investigation  into facts,  could not be allowed to be\nraised for  the first time in appeal before this Court. [807\nF]\n     Ordinarily an  appropriation to  gratuity reserve\twill\nhave to\t be regarded  as a  provision made  for a contingent\nliability, for,\t under a  scheme framed\t by  a\tcompany\t the\nliability to  pay gratuity  to its employee on determination\nof  employment\tarises\tonly  when  the\t employment  of\t the\nemployee is  determined by  death, incapacity, retirement or\nresignation-an event  (cessation of  employment) certain  to\nhappen in  the service\tcareer of  every employee. Moreover,\nthe amount  of gratuity\t payable is usually dependent on the\nemployee's wages  at the  time of  G, determination  of\t his\nemployment and\tthe number of years of service put in by him\nand the\t liability accrues  and enhances  with completion of\nevery year  of service;\t but the  company can work out on an\nacturial valuation  its estimated liability (i.e. discounted\npresent value  of  the\tliability  under  the  scheme  on  a\nscientific basis)  and make  a provision  for such liability\nnot all\t at once  but spread  over a  number of years. If by\nadopting such  scientific method  any appropriation  is made\nsuch appropriation  will constitute a provision representing\nfairly accurately  a known  and existing  liability for\t the\nyear in question; if however, an ad hoc sum\n792\nis appropriated\t without resorting  to any  scientific basis\nsuch appropriation  would also\tbe a  provision intended  to\nmeet a\tknown liability,  though a  contingent one, for, the\nexpression 'liability'\toccurring in  cl. (7)(1)(a)  of Part\nIII of\tSixth Schedule\tto the\tCompanies Act  includes\t any\nexpenditure contracted\tfor and\t arising under\ta contingent\nliability: but\tif the sum so appropriated is shown to be in\nexcess of  the sum  required to meet the estimated liability\n(discounted present  value on a scientific basis) it is only\nthe excess  that will have to be regarded as a reserve under\nclause (7)  (2) of Part III to the Sixth Schedule. [807 G.H;\n808 A-D]\n     In the  instant case  although the\t assessee had  urged\nbefore the  authorities below  that different  treatment for\nthe same  item could not be given for purposes of income tax\nassessment and super profits tax assessment the assessee did\nnot clarify  by placing\t material on  record as\t to  whether\nappropriation was based on any acturial valuation or whether\nit was\tan appropriation  of an\t ad hoc amount a which has a\nvital bearing  on the  question, whether  the  appropriation\ncould be  treated as  a provision or reserve. In the absence\nof proper  material the\t question should  be decided  by the\ntaxing\tauthorities   whether  the   amount  set  apart\t and\ntransferred to\tgratuity reserve by the assessee company was\neither a  provision or\ta reserve  and if the latter to what\nextent. [812 C-E]\n     Standard Mills  Co. Ltd. v. Commissioner of Wealth-Tax,\nBombay,<\/a> 63,  I.T.R.470 & Workmen of William Jacks & Co. Ltd.\nv. Management of Jacks & Co.Ltd<\/a>; Madras. [1971] Supp. S.C.R.\n450 followed.\n     Southern Railway  of Peru\tLtd. v. Owen [1957] A.C. 334\nreferred to.\n     The  appropriations  of  an  amount  by  the  Board  of\nDirectors by  way of  providing for  proposed dividend would\nnot constitute\t'provision', for,  the appropriations cannot\nbe said\t to be by way of providing for any known or existing\nliability, none having arisen on the date when the Directors\nmade recommendation much less on the relevant date after the\nfirst day  of the  previous year  relevant to the assessment\nyear in\t question. This\t by itself  would  not\tconvert\t the\nappropriations into \"reserves\". [813 E-F]\n     The tests\tand guidelines\tlaid down  by this  Court in\nthis respect  are: (1)\tthe true nature and character of the\nappropriation must  be\tdetermined  with  reference  to\t the\nsubstance in  the matter,  which means\tthat one  must\thave\nregard to the intention with which and the purpose for which\nappropriation has been made such intention and purpose being\ngathered from  the  surrounding\t circumstances.\t A  mass  of\nundistributed profits cannot automatically become a reserve.\nSome body  possessing the  requisite authority\tmust clearly\nindicate that  a  portion  thereof  has\t been  earmarked  or\nseparated from\tthe general  mass of  profits with a view to\nconstituting it\t either a  general  reserve  or\t a  specific\nreserve; (2)  the surrounding  circumstances should  make it\napparent that  the amount  so earmark  ed or set apart is in\nfact a\treserve to  be utilised\t in future  for\t a  specific\npurpose on  a specific\toccasion; (3) a clear conduct on the\npart of the Directors in setting apart a sum from out of the\nmass of\t undistributed profits\tavowedly for  the purpose of\ndistribution of\t dividend in the same year would run counter\nto any\tintention of  making that  amount a reserve, (4) the\nnomenclature accorded  to any  particular fund\twhich is set\napart from out of the profits would not be material\n793\nOr decisive  of the  matter; and (5) if any amount set apart\nfrom out  of the  profits A is going to make up capital fund\nof the\tassessee and  would be available to the assessee for\nits business purposes it would become a reserve liable to be\nincluded in  the capital  computation of  the assessee under\nthat Act. [815 F-H, 817 G]\n     The relevant  provisions of  the Companies\t Act clearly\nshow that  creating reserves  out of  the profits is a stage\ndistinct in  point of  fact and anterior in point of time to\nthe stage  of making  recommendation for payment of dividend\nand the scheme of the provisions suggests that appropriation\nmade by\t the Board  of Directors  by way  of recommending  a\npayment of  dividend cannot  in the  nature of\tthings be  a\nreserve. [818 F-G]\n     Judged  in\t the  light  of\t the  above  guidelines\t the\nappropriations made  by the  Directors for proposed dividend\nin the\tcase of\t the concerned\tassessee companies  did\t not\nconstitute 'reserves' and the concerned amounts so set apart\nwould  have   to  be   ignored\tor   excluded  from  capital\ncomputation. [818 H]\n     Standard Mills  Co. Ltd.  v. Commissioner of Wealth-tax\nBombay,<\/a> 63  I.T.R.470, Metal  Box Co. Of India Ltd. v. Their\nWorkmen,<\/a> 73 ITR 67, First National City Bank v. Commissioner\nof Income-Tax,<\/a>\t42 ITR\t67 &  Commissioner  of\tIncome-\t tax\n(Central), Calcutta  v. Standard  Vacuum<\/a> oil Co., 59 ITR 685\nfollowed.\n     Although under  the Companies  Act it  is open  to\t the\nDirectors to  recommend and  the  share-holders\t to  approve\npayment of  dividend from the current year's profits or from\nthe past  year's profits and on transfer of a portion of the\ncurrent year's\tprofit to  the general reserve the augmented\ngeneral reserve\t becomes a  congolmerate fund, having regard\nto the\tnatural course\tof human conduct it is not difficult\nto predicate  that dividends  would ordinarily\tbe paid\t out\nfrom the  current income  rather than from the past savings,\nunless\tthe   directors\t in   their  report   expressly\t  or\nspecifically state  that payment  of dividends would be made\nfrom the past savings. From the commercial point of view, if\nany amount  is required\t for incurring\tany  expenditure  or\nmaking any  disbursement like distribution of dividends in a\ncurrent year,  ordinarily the  same will  come\tout  of\t the\ncurrent income of the company if it is available and only if\nthe sum\t is insufficient  then\tthe  past  savings  will  be\nresorted to for the purpose of incurring that expenditure or\nmaking that  disbursement. Such\t a course would be in accord\nwith the common sense point of view. [822 C-F]\n     In the  absense of\t express indication  to the contrary\nthe normal  rule for a commercial concern would be to resort\nto current  income rather  than past savings while incurring\nany expenditure or making any disbursement. [822 H]\n     Commissioner of  Income-Tax, Bombay  City-l  v.  Bharat\nBijlee Ltd. 107 ITR 30; & Commissioner of Income-Tax, Bombay\nCity-ll v. Marrior (India) Ltd. 120 ITR Sl 2 approved.\n[per A.N. Sen, J.]\n     The amount\t set  apart  for  payment  of  any  dividend\nrecommended by\tthe Board  of Directors is not an amount set\napart for meeting a known or existing\n794\nliability and  cannot be considered to be a \"reserve\" within\nthe meaning  of the  Act for  the purposes of computation of\nthe capital of the company. [832 F]\n     The Companies Act, 1956 provides for the preparation of\nannual balance\tsheet in  the prescribed  form and laying it\nbefore the  shareholders  at  the  annual  general  meeting.\nRegulation 87,\tTable A\t in Schedule I contemplates that the\nBoard may  set aside  out of  the  profits  of\tthe  company\ncertain sum  as \"reserve\"  before dividend is recommended by\nit. The\t amount recommended  by the  Board  for\t payment  of\ndividend is  shown in  the  balance  sheet  under  the\thead\n\"provision\" and\t not under  any head  of \"reserve\". The true\nnature and  character of  the  sum  so\tset  apart  must  be\ndetermined with\t regard to the substance of the matter which\nin this case is that the sum set apart was never intended to\nconstitute a \"reserve' of the company. [833 F, 834G]\n     In law  the liability  for payment\t of dividend  arises\nonly when  the share-holders accept the recommendations made\nby the\tDirectors. Till\t then it is open to the Directors to\nmodify\tor   withdraw  their  recommendation  before  it  is\naccepted by  the shareholders  and it is equally open to the\nshare-holders  not  to\taccept\tthe  recommendation  in\t its\nentirety. Even\tso, for business purposes when the Directors\nmake any  recommendation for  payment of  dividend  and\t set\napart any  amount for  this purpose  the Directors intend to\nmake a provision and do not create any reserve, as Directors\nknow that  their recomendation\tis generally accepted by the\nshareholders as a matter of course. Therefore any amount set\napart for  this purpose\t is understood by persons interested\nin company  matters and\t in dealing with companies to mean a\nprovision for  the payment  of dividend\t to the shareholders\nand is not understood to constitute a \"reserve\". [832 C-F]\n     Commissioner  of  lncome-tax  Bombay  City\t v.  Century\nSpinning and  Manufacturing Co.\t Ltd.<\/a> [1953]  24 I.T.R. 499,\nCommissioner of\t Income Tax  v.\t Standard  Vaccum  oil\tCo.,\n[1966] 59  I.T.R. 685,\tMetal  Box  Co.\t Of  Ltd.  v.  Their\nWorkmen,<\/a> [1963]\t 73 I.T.R, 53, Commissioner of Income-tax v.\nMysore Electrical  Industries Ltd.,<\/a> [1971] 80 l.T.R. 567 and\nKesho Ram  Industries and Cotton Mills Ltd v.Commissioner of\nWealth\tTax   (Central),  Calcutta,  [1966]  59\t I.T.R.\t 767\nreferred to.\n\n\n\nJUDGMENT:\n<\/pre>\n
     CIVIL APPELLATE  JURISDICTION: Civil  Appeal No. 860 of
\n1973.\n<\/p>\n
     From the  judgment and  order dated  the 1st September,
\n1972 of\t the Andhra  Pradesh High Court at Hyderabad in R.C.
\nNo. 10 of 1971.\n<\/p>\n
\t\t\t    AND
\n\t       Civil Appeal No. 1614 (NT) of 1978.\n<\/p>\n
     Appeal by\tSpecial Leave  from the\t judgment and  order
\ndated the 26th July, 1976 of the Calcutta High Court in l.T.
\nReference No.454 of 1974.\n<\/p>\n
\t\t\t    AND
\n\t\t    Review Petition No. 57 of 1980.\n<\/p>\n
795<\/span><\/p>\n
\t\t\t     IN
\n\t  Special Leave Petition (Civil) No. 4602 of 1977
\n     From the  judgment and  order dated the 11th June, 1974
\nof the\tCalcutta High  Court in\t I.T. Reference\t No. 195  of
\n1969.\n<\/p>\n
\t\t\t    AND
\n\t       Tax Reference Case Nos. 2 and 3 of 1977.\n<\/p>\n
     Income-tax Reference  under section  257 of the Income-
\ntax Act, 1961 drawn up by the Income-tax Appellate Tribunal,
\nBombay Bench  ‘B’ in R.A. Nos. 1223 and 1224 (Bom.) of 1972-\n<\/p>\n
73 (I.T. A. Nos. 24 and 25 (Bom.) of 1971-72.<\/span><\/p>\n
\t\t\t    AND
\n\t\t    Tax Reference Case No. S of 1978.<\/p><\/blockquote>\n
     Income Tax\t Reference under  section 257  of the Income
\nTax Act,  1961 made  by the  Income Tax\t Appellate Tribunal,
\nBombay Bench  “D” in  R.A. No. 225 (Bom.) of 1977-78 arising
\nout of S.T.A.No. 36 (Bombay) 1 1976-77.\n<\/p>\n
     A. Subbarao  and Y.V.  Anjaneyulu for  the appellant in
\nCivil Appeal No. 860\/73. E
\n     V.S. Desai,  Dr. Debi Pal, Praveen Kumar and Anil Kumar
\nSharma for  the Appellant  in C.A.  1614 of 1978 and for the
\nPetitioner in Review Petition No. 57\/80.\n<\/p>\n
     K.G. Haji\tand R.J.  John\tfor  the  Appellant  in\t Tax
\nReference Case Nos. 2 and 3 of 1977.\n<\/p>\n
     S.E.  Dastur,   S.N.  Talwar  and\tR.J.  John  for\t the
\nAppellant in Tax Reference Case No. 5 of 1978.\n<\/p>\n
     S.T. Desai,  J. Ramamurthi\t and Miss  A. Subhashini for
\nthe Respondent in Civil Appeal No. 860\/73.\n<\/p>\n
     Miss A.  Subhashini for  the Respondent in Civil Appeal
\nNo.1614 of 1978
\n     S.C.  Manehanda   and  Miss   A.  Subhashini   for\t the
\nRespondent in Tax Reference Nos. 2 and 3 of 1977.\n<\/p>\n
796<\/span><\/p>\n
     S.C. Manchanda,  Anil Dev\tSingh and Miss A. Subhashini
\nfor the Respondent in Tax Reference Case No. 5\/1978.\n<\/p>\n
     S P. Mehta and K.J. John for the Intervener.
\n     Dr. Debi  Paul and\t K.J. John for the Intervener in Tax
\nReference Case No. 5\/1978.\n<\/p>\n
     The following Judgments were delivered:\n<\/p>\n
     TULZAPUKKAR,  J.\tIn  these   Civil  Appeals  and\t Tax
\nReference Cases\t certain common\t questions of  law arise for
\nour determination  and hence  all these\t are disposed  of by
\nthis  common  judgment.\t The  common  questions\t raised\t are
\nwhether amounts retained or appropriated or set apart by the
\nconcerned assessee  company by\tway of\tmaking provision (a)
\nfor taxation,  (b)  for\t retirement  gratuity  and  (c)\t for
\nproposed dividends  from out  of profits and other surpluses
\ncould be  considered as\t “other reserves” within the meaning
\nof Rule\t I of  the Second  Schedule to the Super Profits Tax
\nAct, 1963 (or Rule 1 of the Second Schedule to the Company’s
\n(Profits)  Sur-tax  Act,  1964)\t for  inclusion\t in  capital
\ncomputation of\tthe Company for the purpose of levying super
\nprofit tax ? The first three matters concerning Vazir Sultan
\nTobacco Co.  Ltd; Hyderabad,  Ballarpur lndustries, Ltd; and
\nM\/s. Bengal  Paper Mills  Co. Ltd;  Calcutta arise under the
\nSuper Profits  Tax Act,\t 1963 while  the the  Tax  Reference
\nCases concerning  M\/s. Echjay  Industries Pvt. Ltd. and Hyco
\nProducts  Pvt.\t Ltd.  Bombay\tarise  under  the  Companies
\n(Profits) Sur-tax Act.1 964.\n<\/p>\n
     Since Civil  Appeal  No.  860  of\t1973  (Vazir  Sultan
\nTobacco Company’s  case) is  comprehensive and comprises all
\nthe three  items of  appropriation it  will be sufficient if
\nthe facts  in this  case are  set out  in detail  so  as  to
\nunderstand how\tthe questions  for  determination  arise  in
\nthese matters. Vazir Sultan Tobacco Co. Ltd. was an assessee
\nunder the  Super (Profits)  Tax Act,  1963. For\t the assess-
\nment year  1963-64, for which the relevant accounting period
\nwas the year which ended 30th September, 1962, for computing
\nthe chargeable\tprofits of that year for the purpose of levy
\nof super  profits tax  under the  Act, the  assessee company
\nclaimed that  the appropriations  of a)\t Rs.  33,68,360\t for
\ntaxation, (b)  Rs. 9,08,106  for retirement gratuity and (c)
\nRs. 18,41,820  for dividends  (all of which items were shown
\nunder the  heading ‘current  liabilities and  provisions’ in
\nthe concerned balance-sheet as at 30th Sept. 1962) should be
\nregar-\n<\/p>\n
797<\/span><\/p>\n
ded as\t“other reserves”  within the  meaning of  Rule 1  of
\nSecond\tA   Schedule  to  the  Act  and\t be  included  while
\ndetermining its\t capital.  The\tSuper  Profits\tTax  officer
\nrejected the  assessee’s contention  as in  his opinion\t all
\nthese items  were “provisions  ‘ and  not “reserves”  and as
\nsuch these  had to  be ignored\tor excluded from the capital
\ncomputation of\tthe assessee  company and  on that  basis he
\ndetermined the\tcapital,  and  the  standard  deduction\t and
\nlevied super  profits tax  on that portion of the chargeable
\nprofits of  the previous  year which  exceeded the  standard
\ndeduction. In  the appeal  preferred by the assessee company
\nagainst the  assessment, the  Appellate Commissioner  upheld
\nthe assessee’s\tcontentions and\t held that  those items were
\n“reserves” and\ttook them  into account\t while computing the
\ncapital of  the assessee  company.  In\tthe  further  appeal
\nprefer- red  by\t the  Super  Tax  officer,  the\t Income\t Tax
\nAppellate Tribunal  accepted the Department’s contention and
\nheld that  these were  not “reserves”  within the meaning of
\nRule I\tof the\tSecond Schedule to the Act and as such these
\ncould not  enter into  capital computation  of the  assessee
\ncompany. In the Reference that was made under section 256(1)
\nof the\tIncome Tax  Act, 1961  read with  s. 10 of the Super
\nProfits Tax  Act at the instance of the assessee company the
\nfollowing question of law was referred to the Andhra Pradesh
\nHigh Court for its opinion:\n<\/p>\n
\t  “Whether on  the facts and in the circumstances of
\n     the case the provisions (a) for taxation Rs. 33,68,360,\n<\/p><\/blockquote>\n
     (b) for  retirement gratuity  Rs. 9,08,106\t and (c) for
\n     dividends Rs. 18,41,820, could be treated as ‘reserves’
\n     for computing  the capital\t for the  purpose  of  super
\n     profits tax  under Second Schedule to the Super Profits
\n     Tax Act, 1963 for the assessment year 1963-64 ?” F
\n     The  High\t Court\ton   a\tconsideration\tof   several
\nauthorities answered  the question  in respect\tof the three
\nitems in  favour of  the Revenue  and against  the  assessee
\ncompany and  held that\tthe three  sums so  set apart by the
\nassessee company  in its  balance-sheet were  not “reserves”\n<\/p><\/blockquote>\n
and had to be excluded in the computation of its capital for
\nthe purpose  of levying\t super profits\ttax payable  on\t the
\nchargeable profits  tor the  relevant accounting year. It is
\nthis view  of the High Court that is being challenged by the
\nassessee company in the Civil Appeal No. 86() of 1973 before
\nus.\n<\/p>\n
     In Civil Appeal No. 1614\/1978 (Ballarpur Industries Ltd
\n) and  Review Petition\tNo. 57\tof 1980\t (M\/s. Bengal  Paper
\nMills Co. Ltd.)
\n798<\/span>
\nWe are\tconcerned with only two items of appropriation being\n<\/p>\n
(a) provision  for taxation  and (b)  provision for proposed
\ndividend and  in each  one of  these cases the Calcutta High
\nCourt had  taken the  view  that  these\t two  items  do\t not
\nconstitute “reserves”  and as  such have to be ignored while
\ncomputing the capital of the assessee company.\n<\/p>\n
     In Tax  Reference Case Nos. 2 and 3 of 1977 (M\/s Echjay
\nIndustries  Pvt.  Ltd.)-a  case\t under\tCompanies  (Profits)
\nSurtax Act,  1964,  we\tare  concerned\twith  two  items  of
\nappropriation being (a) provision for taxation (b) provision
\nfor proposed  dividend for  the two assessment years 1969-70
\nand 1970-71  and in each of the years the Taxing Authorities
\nas also\t the Income Tax Appellate Tribunal Bombay have taken
\nthe view that these appropriations did not constitute “other
\nreserves” within  the  meaning\tof  Rule  I  of\t the  Second
\nSchedule to  the Companies  (Profit) Surtax Act, 1954 and as
\nsuch were  not includible  in the capital computation of the
\nassessee company  but in  view of  a divergence\t of  opinion
\nbetween the different High Courts on the point, the Tribunal
\nhas at\tthe instance  of the  assessee company made a direct
\nReference to  this Court under s. 257 of the Income Tax Act,
\n1961 read  with s. 18 of the Companies (Profits) Surtax Act,
\n1964.\n<\/p>\n
     In Tax  Reference Case  No. 5  of 1978  (Hyco  Products
\nPvt.Ltd.)-also a  case under Companies (Profits) Surtax Act,
\n1964 the same question pertaining to dividend alone but in a
\ndifferent form\tarose for  consideration before\t the  Taxing
\nAuthorities and\t the Income  Tax Appellate  Tribunal. It was
\nnot a  case of\t‘proposed dividend’ but the assessee company
\nafter transferring  Rs. 29,77,000  out of the current year’s
\nprofit amounting  to Rs. 61,03,382 to General Reserves, paid
\nout of\tRs. 3,10,450  as dividend  to its share-holders from
\nsuch augmented General Reserves and the question was whether
\nwhile computing\t the capital of the assessee-company for the
\npurpose of  levy of  surtax the\t General Reserves  should or
\nshould not be reduced by the aforesaid sum of Rs. 3,10,450 ?
\nIn other  words, the  question was whether the amount of Rs.
\n3,10,450 could\tnot form part of the General Reserves on the
\nrelevant date  (being 1.1.  1973) for the computation of the
\ncapital ?  The Taxing  Authorities as  well as the Appellate
\nTribunal Bombay\t held that  the said  amount of Rs. 3,10,450
\nhad to\tbe ignored for the purpose of computation of capital
\nfor surtax  purposes because  it  was  not  a  reserve.\t The
\nassessee company  has challenged  this view  of the Tribunal
\nbefore us  in this direct Reference made to this Court under
\ns. 257 of the
\n799<\/span>
\nIncome Tax  Act, 1961  read with  s. 18\t of  the  Companies’
\n(Profits) A Surtax Act, 1964.\n<\/p>\n
     It\t may   be  stated  that\t the  scheme  and  the\tmain
\nprovisions  of\tthe  two  concerned  enactments\t are  almost
\nidentical, the\tobject of  both these  enactments being\t the
\nimposition of  a special  tax on  excess profits  earned  by
\ncompanies. Under  Section 4  of the  1963 Act,\twhich is the
\ncharging provision,  there shall be charged on every company
\nfor every  assessment year commencing on and from 1st April,
\n1963, a\t tax, called the super profits tax, in respect of so
\nmuch of\t its “chargeable  profits” of  the previous  year as
\nexceed\tthe  “standard\tdeduction”  at\tthe  rate  or  rates
\nspecified in  the Third\t Schedule. Section  2(5) defines the
\nexpression “chargeable\tprofits” to mean the total income of
\nan assessee computed under the Income Tax Act, 1961, for any
\nprevious year and adjusted in accordance with the provisions
\nof First Schedule, while Section 2(9) defines the expression
\n“standard deduction” to mean an amount equal to six per cent
\nof the capital of company as computed in accordance with the
\nprovisions of  the Second  Schedule, or\t an  amount  of\t Rs.
\n50,000\twhichever  is  greater.\t In  order  to\tD  determine
\n“standard deduction” it becomes necessary to compute capital
\nof the company in accordance with the rules laid down in the
\nSecond Schedule and rule 1 is relevant for our purposes, the
\nmaterial portion whereof runs as follows:\n<\/p>\n
     “1.  Subject to  the other provisions contained in this
\n\t  Schedule, the\t capital of  a company\tshall be the
\n\t  sum of  the amounts,\tas on  the first  day of the
\n\t  previous year\t relevant to the assessment year, of
\n\t  its paid  up share  capital and of its reserve, if
\n\t  any, credited under the proviso (b) to Clause (vi-\n<\/p><\/blockquote>\n
\t  b) of\t sub-section (2!  of sec.  10 of  the Indian
\n\t  Income Tax  Act, 1922\t or under sub section (3) of
\n\t  sec. 34  of the  Income Tax  Act, 1961, and of its
\n\t  other reserves  in so\t far as the amounts credited
\n\t  to such  other reserves  have not  been allowed in
\n\t  computing its\t profits for  the  purposes  of\t the
\n\t  Indian Income Tax Act, 1922 or the Income Tax Act,
\n\t  1961 .. “<\/p><\/blockquote>\n
     It will be clear from the aforesaid provision of rule 1
\nthat before  any amount\t or sum\t qualifies for\tinclusion in
\ncapital computation of a company two conditions are required
\nto be  fulfilled-(a) that  the\tamount\tor  sum\t must  be  a
\n“reserve” and  (b) the\tsame must  not have  been allowed in
\ncomputing the company’s profits for the purposes of the 1922
\nAct or the 1961 Act. That none of the items
\n800<\/span>
\nof appropriation  either  for  taxation\t or  for  retirement
\ngratuity,  or\tfor  proposed\tdividend  in  the  concerned
\nassessees’ case had been allowed in computing the assessee’s
\nprofits under  the 1961\t Act has not been disputed; in other
\nwords  the   second  condition\t indicated  above  has\tbeen
\nsatisfied. The\tquestion is whether any of these items could
\nbe  treated   as  or  falls  within  the  expression  “other
\nreserves” occurring in the said rule.\n<\/p>\n
     The expression  ‘reserve’ has  not been  defined in the
\nAct and\t therefore one\twould be  inclined to  resort to its
\nordinary natural  meaning as  given in the dictionary but it
\nseems to  us that  the dictionary  meaning, though useful in
\nitself, may  not be sufficient, for, the dictionaries do not
\nmake any  distinction between the two concepts ‘reserve’ and
\n‘provision’ while  giving their\t primary meanings whereas in
\nthe context  of the  legislation with which we are concerned
\nin the\tcase a clear distinction between the two is implied.
\nAccording to  the dictionaries (both oxford and Webster) the
\napplicable primary  meaning of\tthe word  ‘reserve’ is: “tc,
\nkeep for  future use  or enjoyment;  to set  apart for\tsome
\npurpose or  end in  view; to  keep in  store for  future  or
\nspecial\t use;\tto  keep   in  reserve”,  while\t ‘provision’
\naccording to Webster means: “something provided for future.”
\nIn other words according to the dictionary meanings both the
\nwords are more or less synonymous and connote the same idea.
\nSince the  rules for computation of capital contained in the
\nSecond Schedule\t to the\t Act proceed  on the  basis  of\t the
\nformula of  capital plus  reserves-a formula  well-known  in
\ncommercial accountancy,\t it becomes  essential to  know\t the
\nexact  connotation   of\t the   two  concepts  ‘reserve’\t and
\n‘provision’ and\t the distinction between the two as known in
\ncommercial  accountancy.   Besides,  though  the  expression
\n‘reserve’ is  not defined in the Act, it cannot be forgotten
\nthat it\t occurs in  a taxing  statute which is applicable to
\ncompanies only\tand to\tno other  assessable entities and as
\nsuch the  expression will  have\t to  be\t understood  in\t its
\nordinary popular sense, that is to say, the sense or meaning
\nthat is\t attributed to\tit by  men of  business,  trade\t and
\ncommerce and  by  persons  interested  in  or  dealing\twith
\ncompanies. Therefore,  the meanings  attached to  these\t two
\nwords in  the provisions  of the  Companies Act 1956 dealing
\nwith  preparation  of  balance-sheet  and  profit  and\tloss
\naccount would  govern their construction for the purposes of
\nthe two\t taxing enactments.  We might  mention here  that in
\nC.l.T. v.  Century Spinning  and Manufacturing\tCompany\t (1)
\nthis Court after referring to the dictionary
\n801<\/span>
\nmeaning of  the expression  ‘reserve’ observed: “what is the
\ntrue A\tnature\tand  character\tof  the\t disputed  sum\t(sum
\nallegedly set  apart) must  be determined  with reference to
\nthe substance  of the  matter” and  went on to determine the
\ntrue nature  and character  of the  disputed sum  by relying
\nupon the  provisions of\t the Indian  Companies Act 1913, the
\nform and  the contents\tof the balance-sheets required to be
\ndrawn up and Regulation 99 in Table A of the 1st Schedule.\n<\/p>\n
     The distinction  between the  two concepts of ‘reserve’
\nand  ‘provision’   is  fairly\twell-known   in\t  commercial
\naccountancy and the same has been explained by this Court in
\nMetal Box Company of India Ltd. v. Their Workmen<\/a> (1) thus:\n<\/p>\n
\t  “The distinction between a provision and a reserve
\n     is in  commercial accountancy fairly well known. Provi-
\n     sions made\t against anticipated losses and contingencies
\n     are charges  against profits and therefore, to be taken
\n     into account  against gross  receipts in  the P. and L.
\n     account and  the  balance-sheet.  On  the\tother  hand,
\n     reserves are  appropriations of  profits, the assets by
\n     which they\t are represented being retained to form part
\n     of the capital employed in the business. Provisions are
\n     usually shown in the balance sheet by way of deductions
\n     from the  assets in  respect of  which  they  are\tmade
\n     whereas general reserves and reserve funds are shown as
\n     part of  the proprietor’s\tinterest.  (See\t Spicer\t and
\n     Pegler’s Book-keeping  and Accounts, 15th Edition, page\n<\/p><\/blockquote>\n
     42)”.\n<\/p><\/blockquote>\n
In other words the broad distinction between the two is that
\nwhereas a  provision is\t a charge  against the profits to be
\ntaken into  account against  gross receipts  in the  P and L
\naccount, a reserve is an appropriation of profits, the asset
\nor assets  by which it is represented being retained to form
\npart of\t the capital  employed in  the business.  Bearing in
\nmind  the   aforesaid  broad  distinction  we  will  briefly
\nindicate how  the two concepts are defined and dealt with by
\nthe Companies Act, 1956.\n<\/p>\n
     Under s. 210 of the Companies Act, 1956 it is incumbent
\nupon the  Board of  Directors of every company to lay before
\nthe annual  general meeting  of its  share-holders  (a)\t the
\nannual balancesheet  and (b)  the profits  and loss  account
\npertaining to the previous
\n802<\/span>
\nfinancial year.\t Section 211(1) provides that every balance-
\nsheet of  a company  shall give\t a true and fair view of the
\nstate of  affairs of  the company  as  at  the\tend  of\t the
\nfinancial year\tand shall, subject to the provisions of this
\nsection, be in the form set out in Part I of Schedule VI, or
\nnear thereto as circumstances admit or in such other from as
\nmay be\tapproved by  the Central Government either generally
\nor in  any particular  case, while  s. 211(2)  provides that
\nevery profit and loss account of a company shall give a true
\nand fair  view of  the profit or loss of the company for the
\nfinancial year\tand shall, subject as aforesaid, comply with
\nthe requirements of Part Ir of r Schedule VI, so far as they
\nare applicable\tthereto. In  other words  the preparation of
\nbalance-sheet as  well as  profit and  loss account  in\t the
\nprescribed forms  and laying  the  same\t before\t the  share-
\nholders\t at   the  annual   general  meeting  are  statutory
\nrequirements which  the company\t has to observe. The Form of
\nbalance-sheet as  given in  Part I  of Schedule\t VI contains
\nseparate heads\tof ‘reserves  and  Surpluses’  and  ‘current
\nliabilities  and   provisions’\tand   under   the   sub-head
\n‘reserves’ different  kinds of\treserves are  indicated\t and
\nunder sub-head\t‘provisions’ different\ttypes of  provisions
\nare indicated; Part III is the interpretation clause setting
\nout the\t definitions of\t various  expressions  occurring  in
\nParts I\t and Il\t and the  expressions ‘reserve’, ‘provision’
\nand ‘liability’ have been defined in cl. 7 thereof. Material
\nportion of cl. (7) of Part III runs as under:\n<\/p>\n
     “(1) For the  purposes of\tParts I and II of this Sche-
\n     dule, unless the context otherwise requires:\n<\/p><\/blockquote>\n
     (a)  the expression  “provision” shall, subject to sub.
\n\t  cl. (2) of this clause mean any amount written off
\n\t  or retained  by way of providing for depreciation,
\n\t  renewals or  diminution in  value  of\t assets,  or
\n\t  retained  by\t way  of  providing  for  any  known
\n\t  liability of which the amount cannot be determined
\n\t  with substantial accuracy:\n<\/p><\/blockquote>\n
     (b)  the expression  “reserve” shall  not,\t subject  as
\n\t  aforesaid,  include  any  amount  written  off  or
\n\t  retained by  way of  providing  for  depreciation,
\n\t  renewals or  diminution  in  value  of  assets  or
\n\t  retained  by\t way  of  providing  for  any  known
\n\t  liability;\n<\/p><\/blockquote>\n
     (c)  x\tx    x\t  x   x\t   x\tx    x\t  x
\n803<\/span>
\n     and in this sub-clause the expression “liability” shall
\n     include A\tall liabilities\t in respect  of\t expenditure
\n     contracted\t for   and  all\t  disputed   or\t  contingent
\n     liabilities.\n<\/p><\/blockquote>\n
     (2)  Where-\n<\/p><\/blockquote>\n
\t  (a)  any amount  written off or retained by way of
\n\t       providing  for\tdepreciation,  renewals\t  or
\n\t       diminution in  value of\tassets, not being an
\n\t       amount  written\toff  in\t relation  to  fixed
\n\t       assets before  the commencement\tof this Act;
\n\t       or\n<\/p><\/blockquote>\n
\t  (b)  any amount  retained by\tway of providing for
\n\t       any known liability,
\n     is in excess of the amount which, in the opinion of the
\n     directors, is reasonably necessary for the purpose, the
\n     excess shall  be  treated\tfor  the  purposes  of\tthis
\n     Schedule as a ‘reserve’ and not a ‘provision’.”<\/p><\/blockquote>\n
     On a plain reading of cl. 7(1) (a) and (b) and cl. 7(2)
\nabove it  will appear clear that though the term ‘provision’
\nis defined  positively\tby  specifying\twhat  it  means\t the
\ndefinition  of\t ‘reserve’  is\tnegative  in  form  and\t not
\nexhaustive in  the sense  that\tit  only  specifies  certain
\namounts which  are not to be included in the term ‘reserve’.
\nIn other  words the  effect of\treading the  two definitions
\ntogether is  that if any retention or appropriation of a sum
\nfalls within the definition of ‘provision’ it can never be a
\nreserve but  it does  not follow  that if  the retention  or
\nappropriation is  not a\t provision  it\tis  automatically  a
\nreserve and  the question  will have  to be  decided  having
\nregard to  the true  nature and\t character  of\tthe  sum  so
\nretained  or   appropriated  depending\ton  several  factors
\nincluding the intention with which and the purpose for which
\nsuch retention\tor appropriation  has been  made because the
\nsubstance of  the matter  is to\t be  regarded  and  in\tthis
\ncontext the primary dictionary meaning of the term ‘reserve’
\nmay have to be availed of. But it is clear beyond doubt that
\nif  any\t retention  or\tappreciation  of  a  sum  is  not  a
\nprovision, that\t is to\tsay, if it is not designated to meet
\ndepreciation, renewals\tor diminution  in value of assets or
\nany known  liability the  same is not necessarily a reserve.
\nWe are\temphasising this aspect of the matter because during
\nthe hearing almost all counsel for the assessees strenuously
\ncontended before  us that  once it was shown or became clear
\nthat the retention or appreciation of a sum out of
\n804<\/span>
\n     profits and  surpluses was\t for an unknown liability or
\nfor a  liability which did not exist on the relevant date it
\nmust be\t regarded as  a reserve.  The fallacy underlying the
\ncontention  becomes   apparent\tif  the\t negative  and\tnon-
\nexhaustive aspects of the definition of reserve are borne in
\nmind. Having  regard to\t type  of  definitions\tof  the\t two
\nconcepts which\tare to\tbe found  in cl.  7 of Part. III the
\nproper approach\t in our\t view, would  be first\tto ascertain
\nwhether the  particular retention  or appropriation of a sum
\nfalls within  the expression ‘provision’ and if it does then
\nclearly the  concerned sum will have to be excluded from the
\ncomputation of\ta capital,  but in  case  the  retention  or
\nappropriation of  the sum  is not a provision as defined the
\nquestion will  have to\tbe decided  by reference to the true
\nnature and  character of the sum so retained or appropriated
\nhaving regard  to several  factors as mentioned above and if
\nthe concerned sum is in fact a reserve then it will be taken
\ninto account for the computation of capital.\n<\/p>\n
     Having  thus   indicated  the  proper  approach  to  be
\nadopted, we  shall proceed  to deal  with the three items of
\nappropriation  being   (a)  provision\tfor  taxation,\t (b)
\nprovision for  retirement gratuity  and\t (c)  provision\t for
\nproposed  dividends   in  the  case  of\t concerned  assessee
\ncompanies in these Appeals and Tax Reference Cases.\n<\/p>\n
     Dealing first  with the item of appropriation by way of
\nprovision for  taxation, which\tarises in  Civil Appeal\t No.
\n860\/1973 (Vazir\t Sultan Tobacco\t Company), Civil  Appeal No.
\n1614 (NT)\/  1978 (Ballarpur Industries Ltd;) Review Petition
\nNo. 50\/1980  (M\/s. Bengal  Paper Mills\tCo.  Ltd.)  and\t Tax
\nReference Cases\t Nos. 2 & 3\/1977 (M\/s Echjay Industries Pvt.
\nLtd;)-the common  question is  whether the concerned amounts
\nappropriated or\t set apart  by these assessee-companies from
\nout of\tthe profits  and other\tsurpluses by  way of  making
\nprovision for  taxation constitute  a provision or a reserve
\non the\trelevant date,\tbeing the  first day of the previous
\nyear relevant  to the  assessment year\tin question ? Taking
\nVazir Sultan  Tobacco Company’s case as an illustration, for
\nthe assessment\tyear 1963-64  the relevant accounting period
\nwas the year which ended on September 30, 1962; under Rule I
\nof the\tSecond Schedule\t to the\t Super Profits\tTax Act, the
\nfirst day of the previous year would be october 1, 1961 and.
\ntherefore, the balance-sheet of that company as on September
\n30, 1961  and the  profits and\tloss account  which ended on
\nSeptember 30,  1961 would be relevant. It cannot be disputed
\nthat on\t the expiry  of September  30,\t1961,  the  assessee
\ncompany incurred  the taxation\tliability in  respect of the
\nprofits
\n805<\/span>
\nwhich it  had earned  during that  year,  though  the  exact
\namount of  such\t liability  could  not\tbe  determined\twith
\nsubstantial accuracy at that time and the same would have to
\nbe ascertained\tby reference  to rate of taxes applicable to
\nthat year.  The liability for taxation having thus arisen on
\nthe expiry of the last day of the year, the setting apart of
\nthe sum of Rs. 33,68,360 by the Board of Directors will have
\nto be  regarded as  a provision\t for a\tknown  and  existing
\nliability, the\tquantification whereof bad to be done later.
\nOn principle,  therefore, it seems to us clear that the item
\nof Rs.\t33,68,360 which\t had been  set apart by the Board of
\nDirectors for  taxation must  be regarded as a provision and
\ncannot be  regarded as\ta  reserve.  Similar  would  be\t the
\nposition in  regard to\tthe appropriations for taxation made
\nby the other assessee-companies mentioned earlier.\n<\/p>\n
     In this context a reference to this Court’s decision in
\nthe case  of Kesoram  Industries and  Cotton Mills  Ltd.  v.
\nCommissioner of\t Wealth Tax  (Central) Calcutta<\/a>(‘)  would be
\nuseful. In  that case  the question  was whether  a  certain
\namount which  had been set apart as provision for payment of
\nincome-tax and\tsuper tax  was\ta  “debt  owed”\t within\t the
\nmeaning of  s. 2(m) of the Wealth-Tax Act, 1957, as on March
\n31, 1957  which was  the valuation  date  and  as  such\t was
\ndeductible in  computing the  net wealth  of  the  appellant
\ncompany. In  its balance-sheet for the year ending March 31,
\n1957 the  appellant company  had shown\ta certain  amount as
\nprovision for payment of income-tax and super-tax in respect
\nof that\t year of  account and  this Court took the view that
\nthe expression\t“debt owed” within the meaning of s. 2(m) of
\nthe Wealth-Tax\tAct, 1957  could be defined as the liability
\nto pay\tin presenti  or in  futuro an  ascertainable sum  of
\nmoney and that the liability to pay income-tax was a present
\nliability  though  the\ttax  became  payable  after  it\t was
\nquantified in accordance with ascertainable data; that there
\nwas a perfected debt on the last date of the accounting year
\nand not\t a contingent  liability. The Court further observed
\nthat the  rate was  always easily ascertainable; that if the
\nFinance Act  was passed,  it was the rate fixed by that Act;
\nif the\tFinance Act  was not  yet passed,  it was  the\trate
\nproposed in  the Finance  Bill pending before the Parliament
\nor the\trate in\t force in  the preceding  year whichever was
\nmore favourable to the assessee and that all the ingredients
\nof a  “debt” were  present and it was a present liability of
\nan ascertainable  amount and  that, therefore, the amount of
\nprovision for payment of income-tax and super-tax in respect
\nof the year of account ending March 31, 1957 was a “debt H
\n806<\/span>
\nowed” within  the meaning  of s. 2(m) on the valuation date,
\nnamely\tMarch  31,  1957  and  was  as\tsuch  deductible  in
\ncomputing the net wealth. The ratio of this decision clearly
\nsuggests that  the appropriation of the amounts set apart by
\nthe  assessee\tcompanies  before   us\tfor  taxation  would
\nconstitute a  provision made  by them  to meet\ta known\t and
\nexisting liability  and as  such the concerned amounts would
\nnot be includible i n capital computation.\n<\/p>\n
     Counsel  for  the\tassessee  company  in  Vazir  Sultan
\nTobacco\t Company’s  case,  however,  attempted\tto  raise  a
\nfurther plea  that the\tprovision for taxation in the sum of
\nRs. 33,68,360 was an excess provision in the sense it was in
\nexcess of  the amount which was reasonably necessary for the
\npurpose of  taxation and,  there ore,  the excess  should be
\ntreated as  a reserve and not a provision and in this behalf
\nreliance was  placed on\t cl. (7) (2) of Part III of Schedule
\nVT and three decisions-of the Madras High Court Commissioner
\nof Income-tax  Madras v.  Indian Steel Rolling Mills Ltd.<\/a>(l)
\nof the\tHimachal Pradesh High Court in Hotz Hotels Pvt. Ltd.
\nv. Commissioner\t of Income  Tax, Haryana,  H.P. and Delhi(2)
\nand of\tAllahabad High\tCourt in Commissioner of Income-Tax,
\nDelhi v.  Modi Spinning and Weaving Mills<\/a>(3). There could be
\nno dispute about the principle that if provision for a known
\nor existing  liability is  made in excess of the amount that
\nwould be reasonably necessary for the purpose 13: the excess
\nshall have  to be treated as a reserve and, therefore, would
\nbe includible  in the  capital computation  but no such case
\nwas made  out by  the assessee\tcompany at  any stage of the
\nassessment proceedings\teither before the Taxing Authorities
\nor even\t before the  Tribunal or  the High  Court and in the
\nabsence of  any such plea having been raised at any stage of
\nthe proceedings\t it will  not be  proper for  this Court  to
\nallow the  assessee company to raise such a plea, which will
\nneed investigation  into facts,\t for the  first time  in its
\nappeal before  this Court.  The\t contention  is,  therefore,
\nrejected. Dealing  next with  the item of appropriation made
\nfor retirement\tgratuity, which\t arises only in Civil Appeal
\nNo. 860\/1973  (Vazir Sultan  Tobacco Co.)  the\tquestion  is
\nwhether the sum of Rs. 9,O8,106 appropriated or set apart by
\nthe assessee  company from  out of  its\t profits  and  other
\nsurpluses by  way of  providing for retirement gratuity is a
\nprovision or a reserve on the relevant date,
\n807<\/span>
\nviz. 1.10.1961 ? Counsel for the assessee-compaoy vehemently
\nurged before us that this appropriation had not been allowed
\nas a  deduction in  the income-tax assessment proceedings of
\nthe company  for the  relevant assessment year on the ground
\nthat it\t was in\t the nature of a reserve and the entire sum,
\nminus the  actual payments, was added back to the income and
\nprofits of  the assessee-company  and if  that be so, in the
\nsuper profit-tax  assessment  it  cannot  be  treated  as  a
\nprovision and  excluded from  capital computation. According
\nto him\tthere could  not be two different treatments for the
\nsame item  in income-tax  assessment and  super\t profit\t tax
\nassessment.  He\t  pointed  out\t that  this  contention\t was
\nspecifically  urged  in\t the  appeal  before  the  Appellate
\nAssistant Commissioner\tbut was wrongly rejected. He further
\nsubmitted that\tno actuarial  valuation had been undertaking
\nbut ad hoc amount was appropriate or transferred to gratuity
\nreserve and  as such  the same should have been treated as a
\nreserve and  included in  capital computation.\tOn the other
\nhand, counsel  for the\tRevenue seriously  disputed the last
\nsubmission and\tcontended that\tit was never the case of the
\nassessee-company either\t before the  Taxing  Authorities  or
\nbefore the  Tribunal or\t before\t the  High  Court  that\t the
\nappropriation was  or an  ad hoc sum without undertaking any
\nactuarial valuation.  It must  be observed  that whereas the
\nassessee-company did  urge a  contention  before  the  lower
\nauthorities that  different treatments\tfor  the  same\titem
\ncould not  be given for purpose of income-tax assessment and
\nsuper profit-tax  assessment, the  assessee company  did not
\nclarify by  placing material  on record\t as to\twhether\t the
\nappropriation of  the amount  was  based  on  any  actuarial
\nvaluation or  whether it  was an  appropriation of an ad hoc
\namount an aspect which, as we shall presently point out, has
\na vital\t bearing on  the question  whether the appropriation
\ncould be treated as a provision or a reserve. In the absence
\nof proper  material  touching  this  vital  aspect,  we\t are
\nafraid, the  issue in  question will  have to be remanded to
\nthe Taxing  Authorities through the Tribunal for disposal in
\nthe light  of the  well settled\t principles in\tthat behalf,
\nwhich we shall presently indicate.\n<\/p>\n
     Ordinarily an  appropriation to  gratuity reserve\twill
\nhave to\t be regarded  as a  provision made  for a contingent
\nliability, for,\t under a  scheme framed\t by  a\tcompany\t the
\nliability to  pay gratuity to its employees on determination
\nof employment  arises  only  when  the\temployment.  Of\t the
\nemployee is  determined by  death, incapacity, retirement or
\nresignation-an event  (cessation of  employment) Certain  to
\nhappen in  the service\tcareer of  every employee; moreover,
\nthe amount  of gratuity\t payable is usually dependent on the
\nemp-\n<\/p>\n
808<\/span><\/p>\n
loyee’s wages at the time of determination of his employment
\nand the\t number of  years of  service put  in by him and the
\nliability accrues and enhances with completion of every year
\nof service;  but the  company can  work out  on an actuarial
\nvaluation its  estimated liability  (i.e. discounted present
\nvalue of  the liability\t under the  scheme on  a  scientific
\nbasis) and  make a  provision for  such liability not all at
\nonce but  spread over a number of years. It is clear that if
\nby adopting such scientific method any appropriation is made
\nsuch appropriation  will constitute a provision representing
\nfairly accurately  a known  and existing  liability for\t the
\nyear in question; if, however, an ad hoc sum is appropriated
\nwithout resorting to any scientific basis such appropriation
\nwould  also   be  a  provision\tintended  to  meet  a  known
\nliability, though  a contingent\t one,  for,  the  expression
\n‘liability’ occurring  in cl. (7) (1) (a) of Part III of the
\nSixth Schedule to the Companies Act includes any expenditure
\ncontracted for and arising under a contingent liability; but
\nif the\tsum so\tappropriated is shown to be in excess of the
\nsum required  to meet  the estimated  liability\t (discounted
\npresent value  on a  scientific basis) it is only the excess
\nthat will have to be regarded as a reserve under cl. (7) (2)
\nof Part III to the Sixth Schedule.\n<\/p>\n
     In the above context we might refer to one English case
\ndecided by  the House of Lords and two or three decisions of
\nthis Court, which seem to lead to aforesaid propositions. In
\nSouthern Railway  of Peru Ltd. v. Owen(1) an English Company
\noperating a  railway in\t Peru was,  under the  laws of\tthat
\ncountry, liable\t to pay\t its employees\tconpensation on\t the
\ntermination of\ttheir services\teither by  dismissal  or  by
\nnotice\tor  on\tsuch  termination  by  death  or  efflux  of
\ncontractual time.  The compensation  so paid  was an  amount
\nequivalent to one month’s salary at the rate in force at the
\ndate of\t determination for  every year\tof service.  In\t the
\ncomputation of taxable income under the Income-tax Act 1918,
\nthe company  claimed to\t be entitled  to charge against each
\nyear’s\treceipts  the  cost  of\t making\t provision  for\t the
\nretirement payments  which would ultimately be thrown on it,
\ncalculating the\t sum required to be paid to each employee if
\nhe retired  without forfeiture\tat the close of the year and
\n(; setting  aside the  aggregate of  what was required in so
\nfar as\tthe year had contributed to the aggregate. The House
\nof Lords  rejected the\tdeductions on  the  ground  that  in
\ncalculating the\t deductions  the  company  had\tignored\t the
\nfactor of  discount. But,  their  Lordships  recognised\t the
\nprinciple that\tthe company  was entitled to charge, against
\neach year’s receipts, the cost of making the
\n809<\/span>
\nprovision for  the  retirement\twhich  would  ultimately  be
\npayable as  the company\t had the  benefit of  the employee’s
\nservices during\t that year provided the present value of the
\nfuture payments\t could be  fairly estimated. Lord MacDermott
\nobserved at page 345 as follows:\n<\/p>\n
\t  “…. as  a general  proposition it  is,  I  think
\n     right to say that, in computing his taxable profits for
\n     a particular  year, B a trader, who is under a definite
\n     obligation to  pay his  employees for their services in
\n     that year\tan  immediate  payment\tand  also  a  future
\n     payment in\t some subsequent  year, may properly deduct,
\n     not only the immediate payment but the present value of
\n     the future\t payment, provided such present value can be
\n     satisfactorily determined or fairly estimated.”
\n     In Standard  Mills Co.  Ltd. v. Commissioner of Wealth-\n<\/p><\/blockquote>\n
Tax, Bombay  (1) the  question for  decision was  whether an
\nestimated liability  under  gratuity  schemes  framed  under
\nindustrial awards  amounted to ‘debts’ and could be deducted
\nwhile computing the net wealth of the assessee-company under
\nthe Wealth  Tax Act. This Court held in view of the terms of
\ns. 2  (m) of that Act, that as the liability lo pay gratuity
\nwas  not   in  praesenti   but\twould  arise  in  future  on
\ndetermination of the service, i. e. On the retirement, death
\nor termination,\t the estimated\tliability under\t the schemes
\nwould not  be a ‘debt’ and, therefore, could not be deducted
\nwhile computing\t the net wealth. The House of Lords decision
\nin the\tcase of\t Southern Rly.\tOf  Peru  Ltd.\t(supra)\t was
\ndistinguished by  this Court  as having\t no relevance to the
\nquestion before\t it on the ground that the House of Lords in
\nthat decision was concerned in determining the deductibility
\nof the\tpresent value  of a  liability which  may  arise  in
\nfuture in the computation of taxable income for the relevant
\nyear under  the income-tax  laws. It  will thus\t appear that
\nthis Court was of the view that though such a liability is a
\ncontingent liability  and, therefore,  not a ‘debt’ under s.
\n2(m) of\t the Wealth-Tax Act it would be deductible under the
\nIncome Tax Act while computing the taxable profits; in other
\nwords different\t considerations would apply to cases arising
\nunder the Wealth-Tax Act and the Income-Tax Act.\n<\/p>\n
     In Matal Box Co’s case (supra) this Court was concerned
\nwith the  nature of  liability under a scheme of gratuity in
\nthe context  of the  Payment of\t Bonus\tAct,  1965  and\t the
\nquestion related to a sum
\n810<\/span>
\nof Rs.\t18.38 lakhs  being the estimated liability under the
\ntwo gratuity  schemes  framed  by  the\tcompany,  which\t was
\ndeducted from  the gross  receipts in  the P & L Account, it
\nbeing contended on behalf of the workmen that such deduction
\nwas not\t justified while determining the ‘available surplus’
\nand the\t ‘allocable surplus’  for payment  of bonus  to them
\nunder the Payment of Bonus Act, 1965. The Court rejected the
\ncontention and\tadverting to  the decision of House of Lords
\nin the\tcase of Southern Rly. Of Peru Ltd. (supra) held that
\nan estimated  liability under  gratuity schemes\t even if  it
\namounted to  a contingent  liability and  was not  a  ‘debt’
\nunder the  Wealth Tax Act, if properly ascertainable and its
\npresent value  was fairly discounted was deductible from the
\ngross-receipts while  preparing\t the  P\t &  L  Account.\t The
\nmaterial portion  of the  head-note appearing  at page 54 of
\nthe report runs thus:\n<\/p>\n
\t  “Contingent liabilities  discounted and  valued as
\n     necessary,\t can   be  taken  into\taccount\t as  trading
\n     expenses if they are sufficiently certain to be capable
\n     of\t valuation   and  if   profits\tcannot\tbe  properly
\n     estimated without\ttaking them  into consideration.  An
\n     estimated liability  under\t a  scheme  of\tgratuity  if
\n     properly  ascertainable   and  its\t  present  value  is
\n     discounted, is deductible from the gross receipts while
\n     pre paring\t the P\t& L  account. This  is recognised in
\n     trade circles  and there  is nothing  in the  Bonus Act
\n     which prohibits  such  a  practice.  Such\ta  provision
\n     provides for  a known liability of which the amount can
\n     be determined  with substantial  accuracy.\t It  cannot,
\n     therefore,\t be   termed  a\t “reserve”.  Therefore,\t the
\n     estimated liability for the year on account of a scheme
\n     of gratuity  should be  allowed to be deducted from the
\n     gross profits.  The allowance  is not restricted to the
\n     actual payment of gratuity during the year.”\n<\/p><\/blockquote>\n
At page 62 of the Report this Court observed thus:\n<\/p>\n
\t  “Two questions,  therefore, arise:  (I) whether it
\n     is legitimate  in such a scheme of gratuity to estimate
\n     the liability on an actuarial valuation and deduct such
\n     estimated liability  in the P & L Alc while working out
\n     its  net\tprofits;  (2)  if  it  is,  b  whether\tsuch
\n     appropriation amounts to a reserve or a provision?.. In
\n     the case  of an  assessee maintaining  his accounts  on
\n     mercantile system,\t a liability already accrued, though
\n     to be  discharged at  a future  date, would be a proper
\n     deduction while  working out  the profits\tand gains of
\n     his business, re-\n<\/p><\/blockquote>\n
811<\/span><\/p>\n
     gard being\t had to the accepted principle of commercial
\n     A practice\t and accountancy  . It\tis not\tas  if\tsuch
\n     deduction\tis  permissible\t only  in  case\t of  amounts
\n     actually expended or paid. Just as receipts, though not
\n     actual receipts  but accrued  due, are  brought in\t for
\n     income-tax assessment,  so also liabilities accrued due
\n     would be  taken into  account  while  working  out\t the
\n     profits and gains of the business”.\n<\/p><\/blockquote>\n
Again at page 64 of the Report this Court observed thus:\n<\/p>\n
\t  “In the  instant case\t the question is not whether
\n     such estimated  liability arising\tunder  the  gratuity
\n     schemes amounts  to a  debt or  not. The  question that
\n     concerns us  is  whether  while  working  out  the\t net
\n     profits, a\t trader can pro vide from his gross receipts
\n     his liability to pay a certain sum for every additional
\n     year of  service which  he receives from his employees.
\n     This, in  our view,  he can  do if\t such  liability  is
\n     properly ascertainable  and it is possible to arrive at
\n     a proper  discounted  present  value.  Even  if  the  n
\n     liability\tis  a  contingent  liability,  provided\t its
\n     discounted present\t value is  ascertainable, it  can be
\n     taken into\t account. Contingent  liabilities discounted
\n     and valued\t as necessary  can be  taken into account as
\n     trading expenses if they are sufficiently certain to be
\n     capable of\t valuation and if profits cannot be properly
\n     estimated without taking them into account.”
\n     In the  case of Workmen of William Jacks . Co. Ltd. v.\n<\/p><\/blockquote>\n
Management of  Jacks &\tCo. Ltd. Madras (1) another decision
\nunder the  Payments of\tBonus Act,  1965, this\tCourt, after
\nreferring to  the distinction  pointed out in Metal Box Co’s
\ncase between  the two concepts ‘provision’ and ‘reserve’ has
\nobserved on page 547 as follows:\n<\/p>\n
\t  “The\tprovision  for\tgratuity,  furlough  salary,
\n     passage, service  and commission,\tin the\tpresent case
\n     was  all\tmade  in   respect  of\texisting  and  known
\n     liabilities though\t in some  cases the amount could not
\n     be ascertained  with accuracy.  It was not a case where
\n     it was  an anticipated  loss or anticipated expenditure
\n     which  would   arise  in\tfuture.\t Such  provision  is
\n     therefore not a reserve at all and cannot be added back
\n     under item 2 (c) of the Second Schedule.”<\/p><\/blockquote>\n
812<\/span><\/p>\n
     In the above case also the Court was concerned with the
\nquestion whether  particular provision\tmade  for  gratuity,
\nfurlough salary,  passage, etc. was a reserve or a provision
\nfor the\t purpose of  Second Schedule to the Payment of Bonus
\nAct,  1965.  At\t page  546  of\tthe  report  the  Court\t has
\ncategorically  observed\t  that\tall   these  items,  namely,
\ngratuity furlough salary, passage, service, commission, etc.
\nwere clearly  in respect  of liabilities  which had  already
\naccrued in  the years  in which\t the provision\twas made and
\nwere not  in respect  of anticipated liabilities which might
\narise in future and, therefore, the Court held that the said
\nprovision was not a reserve but a provision.\n<\/p>\n
     From the  aforesaid discussion of the case law it seems
\nto us  clear that  the propositions  indicated by us earlier
\nclearly\t emerge.   Since  in  the  instant  case  sufficient
\nmaterial throwing light on the above aspects of the question
\nhas not\t been made  available, we  think, it  will be in the
\ninterest of  justice to remand the case through the Tribunal
\nto the taxing authority to decide the issue whether the con-
\ncerned amount  (Rs. 9,O8,1061-) set apart and transferred to
\ngratuity reserve  by  the  assessee  company  was  either  a
\nprovision or a reserve and if the latter to what extent? The
\ntaxing authority will decide the issue in light of the above
\nprinciples after  giving  an  opportunity  to  the  assessee
\ncompany to place additional relevant materials before
\n     Turning to\t the last  item of  appropriation by  way of
\nprovision for  proposed dividends, which arises in all these
\nmatters (except\t in Tax\t Reference Case\t No. 511978  of Hyco
\nProducts Pvt.  Ltd.) the  common  question  is\twhether\t the
\nconcerned amount  appropriated or set apart by the assessee-
\ncompanies from out of the profits and other surpluses by way
\nof making  provision for  ‘proposed dividends’ constituted a
\nprovision or a reserve on the relevant date ?\n<\/p>\n
     It is  true that under s. 27 of the Companies Act, 1956
\nthe Directors  can merely  recommend that  a certain  sum be
\npaid as\t dividend but such recommendation does not result in
\nany obligation\tor liability; the obligation or liability to
\npay the\t dividend arises  only when the share-holders at the
\nannual general\tmeeting of  the company decide to accept the
\nrecommendation and  pass a resolution for declaration of the
\ndividend. It  is therefore open to the directors to withdraw
\nor modify  their  recommendation  at  any  time\t before\t the
\nshareholders accept  the same  and it is equally open to the
\nshareholders not  to accept  the recommendation at all or to
\ndeclare a dividend of an amount lesser than that recommended
\nby directors. In Kesoram
\n813<\/span>
\nIndustries  case   (supra)  this  Court\t has  clarified\t the
\naforesaid legal\t A position  by observing at page 772 of the
\nreport, thus:\n<\/p>\n
\t  “The directors  cannot  distribute  dividends\t but
\n     they can  only recommend  to the  general body  of\t the
\n     company the  quantum of  dividend\tto  be\tdistributed.
\n     Under section  217 of  the Indian\tCompanies Act, there
\n     shall be  attached to every balance-sheet laid before a
\n     company in\t general meeting  a report  by its  board of
\n     directors with  respect to,  interalia, the  amount, if
\n     any, which it recommends to be paid by way of dividend.
\n     Till the  company in  its general\tbody meeting accepts
\n     the  recommendation  and  declares\t the  dividend,\t the
\n     report of\tthe directors  in  that\t regard\t is  only  a
\n     recommendation which  may be  withdrawn or\t modified as
\n     the case  may be.\tAs on  the valuation date (under the
\n     Wealth Tax\t Act) nothing  further happened\t than a mere
\n     recommendation by\tthe directors  as to the amount that
\n     might be distributed as dividend, it is not possible to
\n     hold that\tthere was  any debt  owed by the assessee to
\n     the share holders on the valuation date.”<\/p><\/blockquote>\n
     All that  follows from  above is  that in\tthe  instant
\ncases the  appropriations of  the concerned  amounts by\t the
\nBoard of Directors by way of providing for proposed dividend
\nwould not  constitute ‘provisions’  for, the  appropriations
\ncannot be  said to  be by  way of providing for any known or
\nexisting liability,  none having arisen on the date when the
\ndirectors made\tthe recommendation much less on the relevant
\ndate being  the first  day of  the previous year relevant to
\nthe assessment\tyear in question. But as stated earlier this
\nby itself  would not automatically convert the appropriation
\ninto ‘reserves’,  regard being\thad to the negative and non-
\nexhaustive character of the definition of ‘reserve’ given in
\ncl. 7  (I)(b) of  Part III  of the  Sixth  Schedule  to\t the
\nCompanies A  ct. The  question whether the concerned amounts
\nin fact\t constituted ‘reserves’\t or  not  will\thave  to  be
\ndecided by having regard to the true nature and character of
\nthe  sums  so  appropriated  depending\ton  the\t surrounding
\ncircumstances particularly  the intention with which and the
\npurpose for which such appropriations had been made.\n<\/p>\n
     We\t have\talready\t indicated  that  according  to\t the
\ndictionaries  (both   oxford  and  Webster)  the  applicable
\nmeaning of the word ‘reserve’ is: “to keep for future use or
\nenjoyment; to  set apart for some purpose or end in view; to
\nkeep in store for future or special
\n814<\/span>
\nuse; to keep in reserve.” In other words, the word ‘reserve’
\nas a  noun in  ordinary parlance would mean “something which
\nis kept\t for future  use or  stored up\tfor something or set
\napart for  some purpose”.  It  cannot  be  disputed  that  a
\nreserve may be a general reserve or specific reserve and all
\nthat is\t required is that an amount should be kept apart for
\nsome purpose,  either general  or  specific.  Eeven  so\t the
\nquestion is  whether the earmarking of a portion of pro fits
\nby the\tboard of  directors of\ta company  avowedly for\t the
\npurpose of  distributing  dividend  would  fall\t within\t the
\nexpression ‘reserve’  occurring in  rule  T  of\t the  Second
\nSchedule to  the Super\tProfits\t Tax  Act,  1963?  For\tthis
\npurpose certain\t tests indicated  in some  decisions of this
\nCourt will have to be considered: The first decision of this
\nCourt in that behalf is the decision in Century Spinning and
\nManufacturing Company’s\t ease  (supra).\t In  that  case\t the
\nmaterial  facts\t  were\tthese:\tFor  the  year\tending\t31st
\nDecember, 1946,\t the profit  of the  assessee-company, whose
\naccounting year\t was the  calendar year,  was a\t certain sum
\naccording to  the profit  and  loss  account.  After  making
\nprovision for  depreciation and taxation, the balance of Rs.
\n5,08,637 was  carried to the balance sheet. This sum was not
\nallowed in  computing the  profits of  the assessee  for the
\npurposes of income tax. On 28th February, 1946, the Board of
\ndirectors recommended  out of  that amount  the sum  of\t Rs.
\n4,92,426 should\t be distributed\t as dividend and the balance
\nof Rs.\t16,211 was  to be carried forward to the next year’s
\naccount. This  recommendation was  accepted  by\t the  share-
\nholders in  their meeting on 3rd April, 1946, and the amount
\nwas shortly afterwards distributed as dividend. In computing
\nthe capital  of the  assessee company  on 1st  April,  1946,
\nunder the  Business Profits  Tax  Act,\t1947,  the  assessee
\nclaimed that  the sum  of Rs. 5,08,637 and the profit earned
\nby it  during the  period 1st  January, 1946  to 1st  April,
\n1946, should  be treated  as “reserves”\t for the  purpose of
\nrule 2(1)  of Schedule\tIT. The High Court held that the sum
\nof Rs. 5,08,637 must be treated as a reserve for the purpose
\nof rule\t 2, but\t the profit made by the assessees during the
\nperiod 1st  January, 1946  to 1st  April, 1946\tcould not be
\nincluded in  the reserves.  On appeal  to this Court, it was
\nheld that  the sum  of Rs.  5,08,637 as\t well as the profits
\nearned by  the assessee\t during the period 1st January, 1946
\nto 1st\tApril, 1946 did not constitute “reserves” within the
\nmeaning of  rule 2 (1) of Schedule II. After noting that the
\nexpression ‘reserve’  had not  been defined  in the Business
\nProfits Tax  Act, 1947\tand after noting dictionary meanings
\nof that expression the Court observed:\n<\/p>\n
815<\/span><\/p>\n
\t  ” What  is the  true nature  and character  of the
\n     disputed A sum must be determined with reference to the
\n     substance of the matter and when this is borne in mind,
\n     it follows\t that the  1st of  April, 1946\twhich is the
\n     crucial date,  the sum  of Rs.  5,08,637 could  not  be
\n     called a  reserve for nobody possessed of the requisite
\n     authority had  indicated on  that date  the  manner  of
\n     disposal or  distination. On  the other  hand, B on the
\n     28th February,  1946 the directors clearly earmarked it
\n     for distribution  as dividend  and did  not make  it  a
\n     reserve. Nor  did the  company in\tits meeting  of\t 3rd
\n     April, 1946  decide that  it was a reserve. It remained
\n     on the 1st of April, as a mass of undistributed profits
\n     which were available for distribution and not earmarked
\n     as “reserve”.  On the  1st of  January, 1946 the amount
\n     was simply\t brought from the profit and loss account to
\n     the next  year and\t nobody with  any authority  on that
\n     date made\tor declared  a reserve. The reserve may be a
\n     general reserve  or a  specific reserve, but there must
\n     be a  clear indication to show whether it was a reserve
\n     either of\tthe one\t or the other kind. The fact that it
\n     constituted a  mass of undistributed profits on the 1st
\n     Jan. 1946\tcannot automatically  make it  a reserve. On
\n     the 1st  April, 1946  which is  the commencement of the
\n     chargeable\t accounting   year,  there   was  merely   a
\n     recommendation by\tthe directors  that  the  amount  in
\n     question should  be distributed  as dividend.  Far from
\n     showing that  the directors  have made  the  amount  in
\n     question a\t reserve it  shows that\t they had decided to
\n     earmark it for distribution as dividend.”<\/p><\/blockquote>\n
     The decision clearly lays down that the true nature and
\ncharacter of  the  appropriation  must\tbe  determined\twith
\nreference to  the substance  of the  matter; obviously\tthis
\nmeans that  one must have regard to the intention with which
\nand the\t purpose for which appropriation has been made, such
\nintention and  purpose being  gathered from  the surrounding
\ncircumstances.\tIn   that  behalf   the\t following   aspects
\nmentioned in  the judgment  provide some  guidelines: (a)  a
\nmass of\t undistributed profits cannot automatically become a
\nreserve and that somebody possessing the requisite authority
\nmust clearly  indicate\tthat  a\t portion  thereof  has\tbeen
\nearmarked or separated from the general mass of profits with
\na view\tto constituting\t it either  a general  reserve or  a
\nspecific reserve,  (b) the  surrounding circumstances should
\nmake it\t apparent that the amount so ear-marked or set apart
\nis in fact a reserve to be utilised in future for a specific
\npurpose and  on a specific occasion, and (c) a clear conduct
\non the
\n816<\/span>
\npart of the directors in setting apart a sum from out of the
\nmass of\t undistributed profits\tavowedly for  the purpose of
\ndistribution as\t dividend in the same year would run counter
\nto any\tintention of  making that  amount a  reserve. It was
\nbecause these  aspects obtained\t in the case that this Court
\ntook the  view that  neither the sum of Rs. 5,08,637 nor the
\nprofits\t earned\t by  the  assessee  during  the\t period\t 1st
\nJanuary, 1946 to 1st April 1946 constituted “reserve” within
\nthe meaning  of Rule 2(1) of Second Schedule of the Business
\nProfits Tax Act, 1947.\n<\/p>\n
     Two more  decisions of this Court one in First National
\nCity Bank v. Commissioner of Income-Tax<\/a> (1) and the other in
\nCommissioner of\t Income-Tax (Central),\tCalcutta v. Standard
\nVacuum<\/a> oil Co.(2) which provide two more guidelines, may now
\nbe considered.\tIn both\t these cases the Court was concerned
\nwith the question whether the amount set apart as “undivided
\nprofit” or  set apart as “earned surplus” in accordance with
\nthe system  of accountancy  which  obtained  in\t the  United
\nStates amounted\t to a  reserve liable  to be included in the
\ncapital computation  under rule\t 2 of  Schedule\t II  of\t the
\nBusiness Profits  Tax Act,  1947.  In  both  the  cases\t the
\nassessees  were\t non-resident  companies  and  followed\t the
\nsystem\tof   accounting\t that\tobtained  in   the  American
\ncommercial world.  In the first case Justice Kapur, speaking
\nfor the\t court, pointed\t out the  difference between the two
\nsystem of accounting at Page 23 of the Report thus:\n<\/p>\n
\t  “In India  at the  end of  an year  of account the
\n     unallocated profit\t or loss  is carried  forward to the
\n     account of\t the next  year, and such unallocated amount
\n     gets merged  in the account of that year. In the system
\n     of accounting  in the  USA each year’s account is self-<\/p><\/blockquote>\n
     contained and  nothing is\tcarried forward.  If afteral
\n     locating the  profits to  diverse heads mentioned above
\n     any balance  remains, it  is credited to the “undivided
\n     profits” which  become part  of the capital fund. If in
\n     any year  as a  result of\tthe allocation there is loss
\n     the accumulated undivided profits of the previous years
\n     are drawn\tupon and  if  that  fund  is  exhausted\t the
\n     banking company  draws upon  the surplus.\tIn its\tvery
\n     nature  the   undivided  profits  are  accumulation  of
\n     amounts of\t residue on  hand at  the end of the year of
\n     successive periods\t of accounting and these amounts are
\n     by the  prevailing accounting practice and the Treasury
\n     directions regarded  as a\tpart of\t the capital fund of
\n     the banking company.’
\n817<\/span>
\n     After quoting with approval the above observations, Mr.
\nA Justice  Shah in Standard Vacuum Oil Co.’s case went on to
\nobserve at page 695 of the report as follows:\n<\/p>\n
\t  “It is  true that  the  court\t in  that  case\t was
\n     dealing with  a case  of  a  banking  company  but\t the
\n     characteristics noted  are not peculiar to the accounts
\n     of\t a   banking  company;\t they  are  applicable\twith
\n     appropriate variations to the accounts of all companies
\n     in\t which\tdifferent  nomenclatures  are  used  in\t the
\n     accounts to designate the residue on hand as ‘surplus’,
\n     ‘ undivided profits’ or ‘earned surplus’.<\/p><\/blockquote>\n
\t  Where the  balance of net profits after allocation
\n     to\t specific  reserves  and  payment  of  dividend\t are
\n     entered  in  the  account\tunder  the  caption  ‘earned
\n     surplus’, it  is intended thereby to designate the fund
\n     which is to be utilised for the purpose of the business
\n     of the  assessee. Such a fund may be regarded according
\n     to the Indian practice as ‘general reserve”)
\nThis Court in the first case held that the amount designated
\nas “undivided  profits” which  was available  for continuous
\nfuture use  of the  business for  the bank was a part of the
\nreserve and had to be taken into account while computing the
\ncapital under  rule 2(1)  of Schedule  II  of  the  Business
\nProfits Tax  Act; similarly,  in the  second case  the Court
\nheld that  the amount  which had  been allocated  to “earned
\nsurplus” which\twas intended for the purpose of the business
\nof the\tassessee company and was used in subsequent years in
\nbusiness, represented ”reserves” within the meaning of rule
\n2 of  Schedule II  of the  Business Profits: Tax. From these
\ntwo decisions  two aspects emerge very clearly. In the first
\nplace, the  nomenclature accorded  to  any  particular\tfund
\nwhich is  set apart  from out  of the  profits would  not be
\nmaterial or  decisive of  the matter  and  secondly,  having
\nregard to  the purpose\tof rule\t of 2  of Schedule II of the
\nBusiness Profits Tax Act, 1947, if any amount set apart from
\nout of\tthe profits  is going to make up capital fund of the
\nassessee and  would be\tavailable to  the assessee  for\t its
\nbusiness purposes,  it would  become a\treserve liable to be
\nincluded in  the capital  computation of  the assessee under
\nthat Act.\n<\/p>\n
     The provisions  of the  Companies Act  1956  also\tlend
\nsupport\t to   the  proposition\tthat  an  appropriation\t for
\nproposed dividend  would not  amount to\t a reserve.  Section
\n217(1) runs thus:\n<\/p>\n
818<\/span><\/p>\n
\t  “217(1) There\t shall be  attached to every balance
\n     sheet laid\t before a  company  in\tgeneral\t meeting,  a
\n     report by its Board of directors, with respect to-\n<\/p><\/blockquote>\n
\t  (a)  the state of the company’s affairs,\n<\/p><\/blockquote>\n
\t  (b)  the amounts,  if any  which  it\tproposes  to
\n\t       carry to any reserves in such balance sheet,\n<\/p><\/blockquote>\n
\t  (c)  the amounts,  if\t any,  which  it  recommends
\n\t       should be paid by way of dividend;\n<\/p><\/blockquote>\n
\t  (d)  …………………………… ”\n<\/p><\/blockquote>\n
Regulation 87 of Table A in the First Schedule runs thus:\n<\/p>\n
\t  “87(1) The  Board  may,  before  recommending\t any
\n     dividend, set  aside out  of the profits of the company
\n     such sums\tas it thinks proper as a reserve or reserves
\n     which  shall,  at\tthe  discretion\t of  the  Board,  be
\n     applicable for  any purpose to which the profits of the
\n     company may  be properly  applied, including  provision
\n     for meeting  contingencies or for equalising dividends;
\n     and  pending   such  application\tmay  at\t  the\tlike
\n     discretion, either\t be employed  in the business of the
\n     company or\t be invested in such investments (other than
\n     shares of\tthe company)  as the Board may, from time to
\n     time, think fit.\n<\/p><\/blockquote>\n
\t  (2)  The Board  may also carry forward any profits
\n\t  which it  may think prudent not to divide, without
\n\t  setting them aside as a reserve.”\n<\/p><\/blockquote>\n
The aforesaid  provisions read\ttogether clearly  show\tthat
\ncreating re serves out of the profits is a stage distinct in
\npoint of  fact and anterior in point of time to the stage of
\nmaking recommendation for payment of dividend and the scheme
\nof the\tprovisions suggests  that appropriation\t made by the
\nBoard of  Directors by\tway of\trecommending  a\t payment  of
\ndividend cannot in the nature of things be a reserve.\n<\/p>\n
     If regard\tbe had to the guide-lines indicated above as
\nwell as\t the provisions\t of the Companies Act 1956 specified
\nabove we  are clearly  of the opinion that the appropiations
\nmade by\t the directors\tfor proposed dividend in the case of
\nthe   concerned\t  assessee-companies   do   not\t  constitute
\n‘reserves’ and the concerned amounts so set apart would have
\nto be ignored or excluded from capital computation.\n<\/p>\n
819<\/span><\/p>\n
     Since we have reached the aforesaid conclusion on first
\nprinciples and\ton the\tbasis of  the  guidelines  discussed
\nabove it  is unnecessary  for us  to go\t into or discuss the
\nscope and  effect of  the Explanation  to Rule\t1 in  Second
\nSchedule to The Companies (Profits) Sur-tax Act, 1964 though
\nit seems  to us\t prime facie  that  the\t Explanation,  being
\nclarifacatory in nature is declaratory of the existing legal
\nposition.\n<\/p>\n
     Dealing with  the last  case of Hyco Products Pvt. Ltd.
\nBombay (Tax  Reference\tCase  No.  5  of  1978),  where\t the
\nquestion pertaining  to dividend  but in  a  different\tform
\narises for  consideration, the admitted facts may briefly be
\nstated. The question relates to the Assessment Year 1974-75,
\nthe relevant  previous year being calendar year 1973 and the
\nmaterial date  being 1.1.1973.\tAfter the  accounts  of\t the
\ncalendar year  1972 were finalised the directors transferred
\nout of\tthe profits  of Rs.  61,03,382 of that year a sum of
\nRs. 29,77,000  to the General Reserve. With such tranfer the
\nGeneral Reserve of the assessee company as on 1.1.1973 stood
\nat Rs.\t86,07,712. At  the end\tof the\tcalendar year,\t1973
\nadmittedly the\tdirectors did  not make\t any  provision\t for
\n‘proposed dividend’  in its  accounts but  there was note on
\nthe Balance Sheets to the following effect:-\n<\/p>\n
\t  “The directors  have recommended  dividend for the
\n     year 1972\tat the\trate of\t Rs. 10\/-  per share free of
\n     tax. The  dividend, if approved by the share-holders at
\n     the forth-\t coming Annual General Meeting, will be paid
\n     out of  General Reserve  and no  separate provision has
\n     been made therefor in the accounts.”\n<\/p><\/blockquote>\n
At the Annual General Meeting held on June 30, 1973 dividend
\nof Rs.\t3,10,450 was  declared by  the share-holders and the
\nsame was  soon thereafter  paid\t out  of  the  said  General
\nReserve. In the surtax assessment proceedings under the 1964
\nAct the\t assessee claimed  that the  entire general  reserve
\nwhich stood  as Rs. 86,07,712 as on 1.1.1973 should be taken
\ninto account  while computing  the capital  of the  assessee
\ncompany. But the taxing officer reduced the general reserves
\nby the aforesaid sum of Rs. 3,10,450 and only the balance of
\nRs. 82,97,262  was  added  in  computing  the  capital.\t The
\nAppellate Assistant  Commissioner as  well as the Income-Tax
\nAppellate Tribunal, Bombay confirmed the order of the Taxing
\nofficer. The Tribunal took the view that though it was not a
\ncase of ‘pro- posed dividend’ since the amount actually paid
\nout  as\t  dividend  was\t  a  smaller  sum  than\t the  amount
\ntransferred from out of profits to
\n820<\/span>
\nthe General  Reserve that  amount could not form part of the
\nreserve and  therefore the General Reserve as reduced by Rs.
\n3,10,450 was  properly taken into account for the purpose of
\ncomputation of\tthe capital  as on the relevant date. At the
\ninstance of  the assessee  the\tTribunal  has  referred\t the
\nfollowing question  of law  directly to\t this Court  for its
\nopinion under s. 257 of the Income Tax Act 1961 read with s.
\n18 of the Companies (Profits) Sur-tax Act, 1964:\n<\/p>\n
\t  “Whether on  the facts and in the circumstances of
\n     the case  the Tribunal was justified in excluding a sum
\n     of Rs. 3,10,450 representing the dividends declared for
\n     the calendar year 1972 from the General Reserves on the
\n     opening date  of the  previous year while computing the
\n     capital under  the Second\tSchedule  of  the  Companies
\n     (Profits) Sur-tax\tAct, 1964  for the  assessment\tyear
\n     1974-75?”<\/p><\/blockquote>\n
     Counsel for  the assessee-company\tcontended that after
\ncon ceding  that this  was not a case of “proposed dividend”
\nthe Tribunal  erred in\tholding that  the sum of Rs 3,10,450
\nrepresenting the dividends paid out from the General Reserve
\nwas liable to be excluded while computing the capital of the
\ncompany as  on 1.1.1973\t for purposes  of sur-tax assessment
\nunder the  1964 Act. According to him under s. 205(1) of the
\nCompanies Act,\t1956 dividend  can be  paid from  out of the
\ncurrent year’s\tprofits or profits of any previous financial
\nyear or\t years and  there is  no presumption  in law  or  in
\ncommercial accounting  that a dividend has to be paid either
\nfrom the  current year’s  profits or  from the\tpast year’ s
\nprofits. He  further urged that once from out of the current
\nyear’s profit\ta  certain sum is transferred to the General
\nReserve it merges into the latter and the General Reserve so
\naugmented becomes  a conglomerate  fund and  if out  of such
\nconglomerate fund  any sum  is recommended  or paid  out  as
\ndividend it  will be  difficult to say that such payment has
\ncome out  of the  portion of current year’s profits that has
\nbeen transferred  and merged  and there is no reason why the
\nprinciple ‘Last-in, First-out’ should be invoked for drawing
\nthe inference  that the\t payment has  been made\t out of\t the
\ncurrent year’s profits. He pointed out that such a principle
\nwas applied  by the  Bombay High  Court\t in  two  decisions,
\nnamely, Commissioner  of Income-Tax, Bombay City-l v. Bharat
\nBijlee Ltd.(1)\tand Commissioner of Income Tax, Bombay City-
\nll v. Marrior (India) Ltd.(2) but urged that there
\n821<\/span>
\nwas no warrant for it. In support of his contention that the
\nentire A  General  Reserve  of\tRs.  86,07,712\twithout\t any
\ndeduction  should   have  been\t taken\tinto  account  while
\ncomputing  the\tcapital\t of  the  assessee-company,  counsel
\nrelied upon  a decision\t of the Andhra Pradesh High Court in
\nSuper Spinning\tMills Ltd.  v. Commissioner  of Income\tTax,
\nHyderabad<\/a>(l).\n<\/p>\n
     Alternatively counsel  pointed out that as far as stock
\nvaluation is  concerned a  question often arises whether the
\nstock on  hand at the end of the year is to be valued at the
\nclosing price  or at  the  initial  purchase  price  and  in
\n‘Advanced Accounting’ by R. Keith Yorston and E. Bryan Smyth
\n(a treatise  on the principles and practice of accounting in
\nAustralia) three  methods of  valuing the closing stock have
\nbeen indicated at pages 441 and 442 of Vol. II (5th Edn.) of
\nthe treatise,  namely, (a)  First-in First-out,\t (b) Last-in
\nFirst-out and  (c) Average  Cost. In  regard to\t these three
\nmethods the authors have stated thus .\n<\/p>\n
     (a) First-in First-out
\n\t  The assumption  underlying this method is that the
\n     oldest stock  is used or issued first or that sales are
\n     made in  the order\t in which the goods are purchased or
\n     produced.\tIf  there  are\tseveral\t lots  of  goods  at
\n     different prices,\tthey are regarded as being exhausted
\n     in the order of purchase. On a rising market this would
\n     write off the lower-priced lots first, and on a falling
\n     market the higher-priced lots would go first.”\n<\/p>\n
     (b) “Last-in First-out.\n<\/p>\n
\t  This\tmethod\tassumes\t that  the  items  of  stock
\n     purchased are  the first  to be issued or sold and thus
\n     the stock\tremaining is  valued  at  the  cost  of\t the
\n     earlier purchase.”\n<\/p>\n
     (c) Average Cost.\n<\/p>\n
\t  On this  basis issues\t of stocks are valued at the
\n     weighted average  cost of\tthe stock  on  hand  at\t the
\n     beginning and of the purchases, less any issues already
\n     made.”\n<\/p>\n
822<\/span><\/p>\n
Counsel for  the assessee urged that for determining whether
\nthe entire  General Reserve  of\t Rs.  86,07,712\t or  reduced
\nGeneral Reserve\t of  Rs.  82,97,262  should  be\t taken\tinto
\naccount for  capital computation either the ‘First-in First-
\nout’  principle\t  should  be   adopted;\t if   not,  only   a
\nproportionate deduction\t should\t be  made  and\tthe  balance
\nshould be  held to  be includible  in  capital\tcomputation,
\nparticularly because the payment of dividend has been from a
\nconglomerate fund.\n<\/p>\n
     It\t is   not  possible   to  accept   either  of  these
\ncontentions urged by counsel for the assessee-company. It is
\ntrue that under s. 205(1) a of the Companies Act, 1956 it is
\nopen to\t the directors to recommend and the share-holders to
\napprove payment\t of dividends either from the current year’s
\nprofits or  from the  past year’s  profits. It\tis also true
\nthat on\t transfer of  a portion of current year’s profits to
\nthe General  Reserve the augmented General Reserve becomes a
\nconglomerate fund but having regard to the natural course of
\nhuman conduct of hard-headed men of business and commerce it
\nis not\tdifficult to  predicate\t that  the  dividends  would
\nordinarily be  paid out\t from the current income rather than
\nfrom the  past savings\tunless the directors in their report
\nexpressly or  specifically state  that payment\tof dividends
\nwould be  made from  the past  savings. From  the commercial
\npoint of  view if  any amount  is required for incurring any
\nexpenditure or\tmaking any disbursement like distribution of
\ndividends in  a current\t year, then ordinarily the same will
\ncome out  of the  current income  of the  company if  it  is
\navailable and only if the same is insufficient then the past
\nsavings will  be resorted  to for  the purpose\tof incurring
\nthat expenditure  or making that disbursement; such a course
\nwould be  in accord  with the common sense point of view. We
\nmay point  out that  this  aspect  of  the  matter  was\t not
\nconsidered  by\tthe  Andhra  Pradesh  High  Court  in  Super
\nSpinning Mills\tLtd. case (supra) and the view of the Bombay
\nHigh Court  in the  case of  Bharat Bijlee  Ltd. (supra) and
\nMarrior (India)\t Ltd. (supra) commends itself to us. Even in
\nregard to  the question\t of valuing  the closing  stock\t the
\nlearned authors\t of the\t treatise referred to by the counsel
\nfor the\t assessee-company merely  indicate three methods for
\nsuch valuation\tand it\twill be open to a commercial concern
\nto avail  of any  one method.  In our view in the context of
\nthe question  whether while  incurring\tany  expenditure  or
\nmaking any  disbursement a commercial concern will resort to
\ncurrent income\tor past\t savings, the  normal rule,  in\t the
\nabsence of  express indication\tto the contrary, would be to
\nresort to the current income rather than past savings.\n<\/p>\n
823<\/span><\/p>\n
     In our  view, therefore,  the  Tribunal  was  right  in
\nexcluding the  sum of Rs. 3,10,450 from the General Reserves
\nwhile computing\t the capital of the assessee-company for the
\nassessment  year   ]974-75,  in\t  the  absence\t of  express
\nindication to the contrary.\n<\/p>\n
     In the  result Civil  Appeal No.  1614(NT) of  1978 and
\nReview Petition\t No. 57\t of 1980 are dismissed. Civil Appeal
\nNo. 860\t of g  1973 is\tpartly allowed and the issue whether
\nthe appropriation  for retirement  gratuity is\ta reserve or
\nnot is\tremanded to the Taxing Authority and the rest of the
\nappeal is  dismissed. In Tax Reference Cases Nos. 2 and 3 of
\n1977 and  No. S\t of 1978  the questions\t referred to  us are
\nanswered  in  favour  of  the  Department  and\tagainst\t the
\nassessee-companies. Each  party will  bear its\town costs in
\nall the matters.\n<\/p>\n
     AMARENDRA NATH  SEN, J. At the outset I wish to observe
\nthat  I\t have  been  somewhat  diffident  in  hearing  these
\nmatters. I  felt a  little embarrassed\tas I found that as a
\nJudge of  the High  Court at  Calcutta, I had an occasion to
\nconsider some  of the  questions in  the case of Braithwaite
\nand Co.\t (India) Ltd.  v. Commissioner of. Income- Tax, West
\nBengal, (I)  (Income Tax  Reference No.\t 262 of\t 1969). As I
\nhave already  considered some  of  the\tquestions  and\thave
\nexpressed my  views on the same in the judgment delivered by
\nme in  the said\t reference, I was wondering whether I should
\nhear  these  appeals.  The  members  of\t the  Bar,  however,
\nrepresented to\tme that they had not only no objection to my
\nhearing these  appeals but they also wanted me to hear these
\nappeals. They further represented that most of the Judges of
\nthis Court  had on  some occasion  or other considered these
\nquestions. They\t further stated\t that if  I would decline to
\ntake up\t these matters\tnot only  the members of the Bar who
\nhad come from various parts of the country for these appeals
\nwould be  seriously inconvenienced;  but also  the  litigant
\npublic who  had been  waiting for  years for  the hearing of
\nthese matters  would be\t prejudiced. It\t was further pointed
\nout to\tme that\t the judgment  which was delivered by me was
\nnot under  appeal and  further\tit  would  appear  from\t the
\njudgment  which\t I  had\t earlier  delivered  in\t Braithwaite
\nmatter, there  was in  fact a concession made by the learned
\ncounsel appearing  on behalf  of the  assessee that the said
\ncase was covered by the decision of the Supreme Court in the
\ncase of\t Commissioner of  Income-tax Bombay  City v. Century
\nSpinning and  Manufacturing Co. Ltd.<\/a> (‘) The learned counsel
\nappearing on behalf
\n824<\/span>
\nof the\tparties further\t represented to\t me that the earlier
\njudgment was  delivered by  me as  a Judge of the High Court
\nand it\twas always  open to  me to  reconsider\t‘  my  view,
\nparticularly as\t a Judge  of this  Court after\thearing\t the
\nsubmissions to\tbe made\t by the learned counsel appearing on
\nbehalf\tof   the  parties.   In\t view\tof   the   aforesaid
\nrepresentations and submissions made by the learned lawyers,
\nI was  persuaded to  hear  these  appeals  with\t my  learned
\nbrothers to  avoid inconvenience not only to the lawyers but
\nto the\tlitigant public. I have also had no doubt in my mind
\nthat if\t I felt\t after hearing\tthe submissions\t made by the
\nlearned counsel\t appearing on behalf of the parties in these
\nappeals, that the earlier judgment delivered by me was wrong
\nand incorrect,\tI would\t have no hesitation in reconsidering
\nmy earlier decision.\n<\/p>\n
     I do  not propose\tto set out the facts of this case at
\nany length  in this  judgment. The facts have been fully and
\ncorrectly set  out in  the judgment  of my  learned  brother
\nTulzapurkar, J.\t My learned brother in his judgment has also
\ndealt with  the various\t arguments which  were advanced from
\nthe Bar\t and has  also considered  the decisions  which were
\ncited.\n<\/p>\n
     I propose\tto notice  only some of the decisions which,
\nto my  mind, are  particularly important for decision of the
\nquestion whether the provision made in the balance-sheet for
\npayment of  dividend to the share-holders recommended by the
\nBoard of  Directors constituted\t a ‘reserve’ and the amount,
\nso set apart, should be taken into account, in computing the
\ncapital of  the company for the purpose of Super-Profits Tax
\nAct, 1963.  It may  be noted  that in  the  Act\t itself\t the
\nexpression ‘reserve’ has not been defined.\n<\/p>\n
     In the  case of Commissioner of Income-tax, Bombay City
\nv. Century Spinning and Manufacturing Co. Ltd.<\/a> (supra), this
\nCourt had  the occasion\t to consider the meaning of the word
\n‘reserve’ while\t dealing with  a case under Business Profits
\nTax Act\t (XXI of 1947). In this Act also, there were similar
\nprovisions with\t regard to computation of the capital of the
\nCompany\t and  the  assessee  had  claimed  that\t the  amount
\nrecommended by\tthe Board  of Directors\t and  earmarked\t for
\npayment of  the dividend  to  the  share-holders  should  be
\ntreated as  ‘reserve’ and should be taken into consideration
\nin computing  the capital of the assessee. The Supreme Court
\nobserved at pp. 503-504 as follows :-\n<\/p>\n
\t  “The term  ‘reserve’ is not defined in the Act and
\n     we must  resort to\t the  ordinary\tnatural\t meaning  as
\n     understood
\n825<\/span>
\n     in common\tparlance. The dictionary meaning of the word
\n     ‘reserve’ is :-\n<\/p><\/blockquote>\n
\t       “1 (a)  To keep\tfor future use or enjoyment;
\n\t  to store  up for some time or occasion; to refrain
\n\t  from using or for enjoying at once.\n<\/p><\/blockquote>\n
\t       (b) To keep back or hold over to a later time
\n\t  or place or for further treatment.\n<\/p><\/blockquote>\n
\t       6. To set apart for some purpose or with some
\n\t  end in view; to keep for some use.\n<\/p><\/blockquote>\n
\t       II.  To\t retain\t or   preserve\tfor  certain
\n\t  purposes (oxford Dictionary, Vol . VIII, P. 513.)
\n\t       In  Webster’s  New  International  Dictionary
\n\t  Second Edition,  page 2118 ‘reserve’ is defined as
\n\t  follows:\n<\/p><\/blockquote>\n
\t       1. To  keep in  store for  future or  special
\n\t  use; to  keep in  reserve; to\t retain, to keep, as
\n\t  for oneself.\n<\/p><\/blockquote>\n
\t       2. To  keep back; to retain or hold over to a
\n\t  future time or place.\n<\/p><\/blockquote>\n
\t       3. To preserve.”<\/p><\/blockquote>\n
     The Supreme  Court further observed at p. 504: “What is
\nthe true  nature and  character of the disputed sum, must be
\ndetermined, with  reference to the substance of the matter?”
\nThe Supreme Court held at p. 504-505 as follows :-\n<\/p>\n
\t  “A reserve  in the  sense in\twhich it  is used in
\n     rule 2 can only mean profit earned by a company and not
\n     distributed as  dividend to  the shareholders  but kept
\n     back by  the directors  for any purpose to which it may
\n     be put  in future.\t Therefore, giving  to the ‘reserve’
\n     its plain\tnatural meaning\t it is clear that the sum of
\n     Rs. 5,08,637   was\t kept in  reserve by the company and
\n     not distributed  as profits  and subjected to taxation.
\n     Therefore, it satisfied all the requirements of rule 2.
\n     The Directors  had no  power to  distribute the  sum as
\n     dividend. They could only recommend as indeed they did,
\n     and it  was upto  the shareholders\t of the\t company  to
\n     accept that recommendation in which case alone the
\n826<\/span>
\n     distribution could\t take place.  The recommendation was
\n     accepted and  the dividend was actually distributed. It
\n     is, therefore,  not correct  to say that the amount was
\n     kept back.\t The nature  of the amount which was nothing
\n     more than\tthe undistributed  profits of  the  Company,
\n     remained unaltered.  Thus the  profits Lying unutilised
\n     and not  specially set  apart for\tany purpose  on\t the
\n     crucial date  did not  constitute reserves\t within\t the
\n     meaning of Schedule II, rule 2(1).”<\/p><\/blockquote>\n
     The Supreme Court also referred to S.l31 (a) and 132 of
\nthe Indian  Companies Act.  Referring to  these sections the
\nSupreme Court observed at p. 505 as follows:\n<\/p>\n
\t  “Section 131\t(a) enjoins  upon the  directors  to
\n     attach to\tevery balance sheet a report with respect to
\n     the state\tof company’s  affairs and  the amount if any
\n     which they\t recommend to be paid by way of dividend and
\n     the amount,  if any, which they propose to carry to the
\n     reserve fund,  general reserve  or reserve account. The
\n     latter section  refers to\tthe contents  of the balance
\n     sheet which  is to\t be drawn  up in  the Form marked in
\n     Schedule III.  This Form  contains a  separate head  of
\n     reserves. Regulation  99 of  the Ist Schedule. Table A,
\n     lays down\t‘that the directors may, before recommending
\n     any dividend  set aside  out  of  the  profits  of\t the
\n     company such  sums as they think proper as a reserve or
\n     reserves  which   shall,  at   the\t discretion  of\t the
\n     directors, be  applicable for meeting contingencies, or
\n     for equalising  dividends, or  for any other purpose to
\n     which the\tprofits\t of  the  company  may\tbe  properly
\n     applied.. ‘ The Regulation suggests that any sum out of
\n     the profits  of the  company which\t is to\tbe made\t asa
\n     reserve or\t reserves  must\t be  set  aside\t before\t the
\n     directors recommend  any dividend.\t In  this  case\t the
\n     directors while recommending dividend took no action to
\n     set aside\tany portion  of this  sum as  a\t reserve  or
\n     reserves. Indeed, they never applied their mind to this
\n     aspect of the matter. The balance sheet drawn up by the
\n     assessee  as   showing  the  profits  was\tprepared  in
\n     accordance with  the provisions of the Indian Companies
\n     Act. These provisions also support the conclusion as to
\n     what is the true nature of a reserve shown in a balance
\n     sheet.”<\/p><\/blockquote>\n
     In the  case of  Commissioner of Income Tax v. Standard
\nVacuum<\/a> oil  Co. (1)  this Court had occasion to consider the
\ndecision in
\n827<\/span>
\nthe case  of Commissioner  of Income-tax v. Century Spinning
\nand A  Manufacturing Co. Ltd.<\/a> (supra). Dealing with the said
\ndecision of this Court held at p. 697-98 as follows :-\n<\/p>\n
\t  “The Court  was dealing  in  this  case  with\t the
\n     accounts of  an Indian  Company, the  balance-sheet  of
\n     which was\tprepared according  to the provisions of the
\n     Indian Companies  Act, 1913. Regulation 99 of the First
\n     Schedule, Table  A, required  that reserves must be set
\n     apart before the directors recommended any dividend but
\n     out of  the profits  of the  company no  amount was set
\n     apart towards reserves before the directors recommended
\n     payment of\t dividend to  the shareholders. The identity
\n     of the  amount remaining  on hand\tat the\tfoot of\t the
\n     profit and\t loss account  was not\tpreserved. rt  is on
\n     these facts  that the  court held\tthat  there  was  no
\n     allocation of  the amount\tto reserve and from the mere
\n     fact that\tit was carried forward in the account of the
\n     next  year\t  and  ultimately   applied  in\t payment  of
\n     dividend, it  could not  be said to be specifically set
\n     apart for\tany purpose  at the relevant date, i. e. the
\n     end of the year of account.”<\/p><\/blockquote>\n
     This Court\t then proceeded\t to hold  at  p.  697-98  as
\nfollows :-\n<\/p>\n
\t  “We are  in  this  case  dealing  with  a  foreign
\n     company and  the system  of accounting  followed by the
\n     company is\t different in  important respects  from\t the
\n     system which  obtains  in\tIndia.\tCompanies  in  India
\n     maintain diverse  types of\t reserves: such\t as  capital
\n     reserve, reserve  for redemption of debentures, reserve
\n     for replacement  of plant\tand machinery,\treserve\t for
\n     buying new\t plant to  be added  to the  existing  ones,
\n     reserve for bad and doubtful debts? reserve for payment
\n     of dividend  and general reserve. Depreciation reserves
\n     within the\t limit prescribed  by the  Income-tax Act or
\n     the Rules\tthereunder is  the only\t reserve which\tis a
\n     permissible allowance  in the  computation\t of  taxable
\n     profits.  In   its\t ordinary   meaning  the  expression
\n     ‘reserve’ means  something specifically  kept apart for
\n     future use or for a specific occasion.”<\/p><\/blockquote>\n
     In the case of Metal Box Company of India Ltd. v. Their
\nWorkmen,<\/a> (1)  this Court while dealing with a case under the
\npay-\n<\/p>\n
828<\/span><\/p>\n
ment of\t Bonus\tAct,  1965  had\t occasion  to  consider\t the
\nexpression ‘reserve’  and its meaning for the purpose of the
\nsaid Act. This Court held at p. 67-68 as follows :-\n<\/p>\n
\t  ” The\t next question\tis  whether  the  amount  so
\n     provided is  a provision or a reserve. This distinction
\n     between a\tprovision and  a reserve  is  in  commercial
\n     accountancy fairly\t well known. Provisions made against
\n     anticipated  losses   and\tcontingencies\tare  charges
\n     against profits and therefore, to be taken into account
\n     against gross  receipts in\t the P\t& L  account and the
\n     balance-sheet.  On\t  the  other   hand   reserves\t are
\n     appropriations of\tprofits, the asset by which they are
\n     represented being\tretained in form part of the capital
\n     employed in  the business. Provisions are usually shown
\n     in the  balance-sheet by  way of  deductions  from\t the
\n     assets in\trespect\t of  which  they  are  made  whereas
\n     general reserves and reserve funds are shown as part of
\n     the proprietor’s  interest\t (see  Spicer  and  Pegler’s
\n     Book-keeping and  Accounts,  15th\tEdn.  page  42).  An
\n     amount set\t aside out  of profits\tand other surpluses,
\n     not  designed   to\t meet\ta  liability,\tcontingency,
\n     commitment or  diminution in  value of  assets known to
\n     exist at the date of the balance-sheet is a reserve but
\n     an amount\tset aside out of profits and other surpluses
\n     to provide\t for any known liability of which the amount
\n     cannot be\tdetermined with\t substantial accuracy  is  a
\n     provision; (see  William  Pickles\tAccountancy,  Second
\n     Edn. p.  192; Part\t III, clause  7, Schedule  VI to the
\n     Companies\tAct,   1958,  which  derives  provision\t and
\n     reserve.”\n<\/p><\/blockquote>\n
In  the\t  case\tof  Commissioner  of  Income-tax  v.  Mysore
\nElectrical Industries  Ltd.<\/a>(1) the  facts  were\t briefly  as
\nfollows:-\n<\/p>\n
     Out of  the profits  of the  company for the accounting
\nperiod ending  March 31,  1963. the Directors of the company
\nappropriated  the  following  amounts  towards\treserves  on
\nAugust 8,  1963: (i) Rs. 2,56,000 as plant modernisation and
\nrehabilitation\treserve:  (ii)\tRs.  89,557  as\t development
\nrebate reserve. The question was whether these amounts could
\nbe included in computing the capital of the respondent as on
\nApril 1,  1963 under  rule 1 of Schedule II to the Companies
\n(Profits)  Sur-tax   Act,  1964.  for  the  purpose  of\t the
\nstatutory deduction  for the  assessment year  1961-65,\t The
\ncontention  of\t the   department   was\t  that\t since\t the
\nappropriations were  made on 8th August, 1963 they could not
\nbe treated  as components  of capital as on the first day of
\nthe previous year i.e. 1st April, 1963. Negativ-\n<\/p>\n
829<\/span><\/p>\n
ing the\t contention of\tthe department, this Court held that
\nthe  determination  of\tthe  Directors\tto  appropriate\t the
\namounts of  the three  items of\t reserve on 8th August, 1963
\nhad to\tbe related to first April, 1963, viz., the beginning
\nof the\taccounts for  the new year, and had to be treated as
\neffective from\tthat day  and the said three items had to be
\nadded to  the other  items for computation of the capital of
\nthe company as on first April, 1963 under rule 1 of Schedule
\nII to  the Companies  (Profits) Sur-tax Act, 1964. It may be
\nnoted that  in this  case before the trial court a claim had
\nbeen made  by  the  company  that  a  sum  of  Rs.  3,15,000
\nrepresenting  dividend\treserve\t was  to  be  considered  in
\ncomputing  the\t assessee’s  capital   for  the\t purpose  of
\nCompanies (Profits) Sur-tax Act, 1964 and the High Court had
\nrejected this  claim. As against the rejection of this claim
\nby the\tHigh Court,  no appeal\thad been  preferred  by\t the
\nassessee to  the Supreme  Court.  The  Supreme\tCourt  while
\nconsidering the\t three items which came up for consideration
\nbefore it  held, as  already noted, that the decision of the
\ndirectors to appropriate the amounts to these three items of
\nreserve on  8th August, 1963 had to be related to 1st April,
\n1963 and this Court observed at pp. 560-570 as follows:-\n<\/p>\n
\t  “It is well known that the accounts of the company
\n     have to  be made  up for a year up to a particular day.
\n     In this  case that\t day was the 31st March, 1963. If it
\n     was reasonably  practicable to  make up the accounts up
\n     to the  31st March,  1963, and  present the same to the
\n     directors of  the respondent  on April  1,\t 1963,\tthey
\n     could have made up their minds on that day and declared
\n     their intention  of appropriating\tthe said  and  other
\n     sums to  reserves of different kinds. But the fact that
\n     they could\t not do\t so for\t the simple  reason that the
\n     calculation and  collection of figures of all the items
\n     of income\tand expenditure\t of the company for the year
\n     ending March  31, 1962,  was bound\t to take  some\ttime
\n     cannot make  any difference to the nature or quality of
\n     the  appropriation\t  of  the  profits  to\treserves  as
\n     determined by  the directors  after the first of April,
\n     1963.  Their  determination  to  appropriate  the\tsums
\n     mentioned to  the three separate classes of reserves on
\n     the 8th  August, 1963,  must be  related to  the 1st of
\n     April, 1963,  i.e., the  beginning of  the accounts for
\n     the new year and must be treated as effective from that
\n     day”.<\/p><\/blockquote>\n
830<\/span><\/p>\n
     Relying on\t the aforesaid decisions and also many other
\ndecisions  of  the  various  High  Courts  which  have\tbeen
\nconsidered by  my learned  brother Tulzapurkar,\t J.  in\t his
\njudgment, the  learned counsel\tfor the\t assessee has argued
\nthat the  word ‘reserve’  which has  not been defined in the
\nAct, has  to be\t understood in\tits ordinary meaning as laid
\ndown by\t the Supreme  Court in\tthe case of Century Spinning
\nMills Ltd.  The further\t argument is that the recommendation
\nfor dividend by the directors of the Company does not create
\nany kind  of liability,\t immediate or  future. It  is argued
\nthat the obligation to pay the dividend only arises when the
\nshareholders at\t the Annual  General Meeting  of the Company
\ndecided to  accept the\trecommendation of  the Directors and
\npass  a\t resolution  for  declaration  of  dividend.  It  is
\nsubmitted that\tit is  open to\tthe Directors to withdraw or
\nmodify the  recommendations made by them any time before the
\nshareholders accept  the recommendations  and in  support of
\nthis contention\t reference is  made to\tthe decision of this
\nCourt in  the case  of Keshoram\t Industries and Cotton Mills
\nLtd. v.\t Commissioner of  Wealth Tax (Central), Calcutta (I)
\nand<\/a> n reliance is placed on the following observations at p.
\n772 :-\n<\/p>\n
\t  “The directors  cannot  distribute  dividends\t but
\n     they can  only recommend  to the  general body  of\t the
\n     company the  quantum of  dividend\tto  be\tdistributed.
\n     Under section  217 of  the Indian\tCompanies Act, there
\n     shall be  attached to every balance-sheet laid before a
\n     company in\t general meeting  a report  by its  board of
\n     directors with  respect to,  inter alia, the amount. if
\n     any, which it recommends to be paid by way of dividend.
\n     Till the  company in  its general\tbody meeting accepts
\n     the recommendations  and  declares\t the  dividend,\t the
\n     report of\tthe directors  in  that\t regard\t is  only  a
\n     recommendation which  may be  withdrawn or\t modified as
\n     the case  may be.\tAs on  the  valuation  date  nothing
\n     further happened  than a  mere  recommendation  by\t the
\n     directors as to the amount that might be distributed as
\n     dividend, it is not possible to hold that there was any
\n     debt owed\tby the\tassessee to the share holders on the
\n     valuation date.”\n<\/p><\/blockquote>\n
It is further argued that it is open to the share-holders to
\naccept the  i recommendations  in its  entirety or to modify
\nthe same by
\n831<\/span>
\ndeciding to  declare dividend  at a  rate lower than the one
\nrecommended by\tthe directors.\tIt is,\ttherefore, contended
\nthat the  recommendation of  the directors  for\t payment  of
\ndividend does  not have\t the effect  of creating any kind of
\nliability and there is no debt owed by the company by virtue
\nof the\tsaid recommendations. It has been submitted that the
\ndecision of  this Court\t in the\t case of  Mysore  Electrical
\nIndustries Ltd.\t (supra) is  of no  assistance and  the said
\ndecision does  not lay\tdown that  in the event of the share
\nholders’ acceptance  of recommendation made by the directors
\nfor the distribution of dividend to the share-holders of the
\ncompany, the liability for payment of the dividend will also
\nrelate back;  and the doctrine of relation-back applies only
\nin respect  of items  which the\t directors are\tcompetent to
\ndecide for  themselves, in  view of  the process involved in
\nthe preparation of accounts of the company.\n<\/p>\n
     The main  argument advanced on behalf of the Revenue is
\nthat any  amount which\tmay be\tset  apart  for\t payment  of
\ndividend r  recommended to  be paid  by the Directors cannot
\nconstitute ‘reserve’ within the meaning of the Act.\n<\/p>\n
     The argument advanced on behalf of the assessee appears
\nto be  sound; but  to my  mind the  said arguments  are\t not
\nsufficiently convincing\t to lead the Court to the conclusion
\nthat  the   amount  set\t  apart\t for   payment\tof  dividend
\nrecommended  by\t  the  Board  of  Directors  can  constitute
\n‘reserve’ within  the meaning  of the Act for the purpose of
\ncomputation of the capital of the Company.\n<\/p>\n
     The word  ‘reserve’ has not been defined in the ACT. In
\nthe absence  of any  such definition  the  word\t has  to  be
\nunderstood in  its ordinary  sense. It\tis, however,  to  be
\nremembered that\t the word  ‘reserve’  in  the  instant\tcase
\noccurs in a taxing statute specially applicable to Companies
\nonly. The  word ‘reserve’  should be so construed as to give
\nthe  said  word\t the  meaning  in  which  it  is  ordinarily
\nunderstood by  persons interested in Companies or in dealing
\nwith Companies.\t In other  words, the word ‘reserve’ for the
\npurpose of  this Act  should be\t understood in\tthe sense in
\nwhich it  is understood\t in company  circles and  by persons
\ninterested in  Companies and  in dealing  with Companies. It
\nmay be\tnoticed that  while considering the true meaning and
\ntrue nature  of ‘reserve’,  the Supreme Court in the case of
\nCommissioner  of   Income  Tax\t v.  Century   Spinning\t and
\nManufacturing Co. Ltd.<\/a> (supra) has referred
\n832<\/span>
\nto S.  131 (a)\tand 132\t of the Indian Companies Act, to the
\nForm marked  in Schedule  III in  which balance sheet of the
\nCompany has  to be prepared and also to Regulation 99 of the
\nFirst Schedule,\t Table A. I have earlier quoted the relevant
\nobservations of the Supreme Court.\n<\/p>\n
     It is,  no doubt, true that the re commendations of the
\nDirectors for  payment of  any dividend\t does not create any
\nkind of\t liability for\tthe payment  of the said amount. The
\nliability for  payment of any amount by way of dividend only
\narises when the share-holders accept the recommendations and
\na dividend  is declared at the annual general meeting of the
\nCompany. It  is open  to the Directors to modify or withdraw
\nthe recommendation  with regard\t to the\t payment of dividend
\nbefore the  said recommendation\t is accepted  by the  share-
\nholders. It  is also open to the share-holders not to accept
\nthe recommendation  of the  Directors in its entirety and to
\nmodify the  same. The legal liability for the payment of any
\ndividend only  arises after  the share-holders at the annual
\ngeneral meeting\t have decided  to declare  a dividend on the
\nbasis of  the recommendations  of the  Directors or  on\t the
\nbasis of  any modification  thereof. The  liability for\t the
\npayment of  dividend only arises after the dividend has been
\ndeclared by  the share-holders at the annual general meeting
\nand this  liability does  not relate  back to  3 any earlier
\ndate on\t the basis  of the recommendations of the directors.
\nas the\tdirectors do  not enjoy any power of declaring the b
\ndividend. The  amount that  may be  set apart for payment of
\nany dividend on the basis of the recommendations made by the
\nDirectors, cannot  be considered  to be\t an amount set apart
\nfor meeting a known or existing liability.\n<\/p>\n
     Though the amount which is set apart for payment of any
\ndividend recommended  by the  Board of\tDirectors is  not an
\namount\tset   apart  for   meeting  any\t known\tor  existing
\nliability, yet\tthe said  amount  so  set  apart  cannot  be
\nconsidered to  be a  ‘reserve’ within the meaning of the Act
\nfor the\t purpose  of  computation  of  the  capital  of\t the
\nCompany.\n<\/p>\n
     S. 210 of the Companies Act, 1956 specifically provides
\nthat at\t every annual general meeting of a Company the Board
\nof Directors  of a  Company shall lay before the Company the
\nbalance sheet  of the  Company and also the Profits and Loss
\naccount. S. 211
\n833<\/span>
\nfurther provides that every balance sheet of a Company shall
\ngive a\tA true\tand fair view of the state of affairs of the
\nCompany as  at the  end of  the Financial  Year\t and  shall,
\nsubject to the provisions of the section, be in the form set
\nout in\tPart I\tof  Schedule  VI,  or  as  near\t thereto  as
\ncircumstances admit or in such other form as may be approved
\nby the\tCentral Government  either generally  or in a parti-
\ncular case.  The preparation  of  a  balance  sheet  in\t the
\nprescribed form and laying the same before the share-holders
\nat the\tannual meeting\tare statutory requirements which the
\nCompany has to observe.\n<\/p>\n
     Regulation 87 of Table A in Schedule I provides:
\n\t  “(1)\tThe   Board  may,  before  recommending\t any
\n     dividend, set  aside out  of the profits of the Company
\n     such sums\tas it thinks proper as a reserve or reserves
\n     which  shall,  at\tthe  discretion\t of  the  Board,  be
\n     applicable for  any purpose to which the profits of the
\n     Company may  be properly  applied, including provisions
\n     for meeting  contingencies or for equalising dividends;
\n     and  pending   such  application,\t may  at   the\tlike
\n     discretion, either\t be employed  in the business of the
\n     company or\t be invested in such investments (other than
\n     shares of\tthe Company)  as the  Board may from time to
\n     time, think fit.\n<\/p>\n
\t  (2) The  Board may  also carry forward any profits
\n     which it  may think  prudent  not\tto  divide.  without
\n     setting them aside as a reserve”.\n<\/p>\n
This Regulation\t contemplates that  the Board  may set aside
\nout of\tthe profits  of the  Company such sums, as it thinks
\nproper, as  a  reserve\tor  reserves  which  shall,  at\t the
\ndiscretion of  the Board,  be applicable  for any purpose to
\nwhich the  profits of  the Company  may be  properly applied
\nincluding the  provisions for  meeting contingencies  or for
\nequalising the\tdividends, before recommending any dividend.
\nIn other  words, the  sums out of the profits of the Company
\nhave to\t be set\t apart as  reserve before  any\tdividend  is
\nrecommended by\tthe Board;  and the  recommendation  of\t the
\nBoard for  payment of dividend comes only after the creation
\nof reserve. The amount that may, therefore, be set apart for
\npayment of  dividend recommended  by the  Board is an amount
\nwhich is set apart
\n834<\/span>
\nafter the Board had created the reserve. The form of balance
\nsheet referred\tto in  S. 211  of the Companies Act, 1956 is
\nappended in  Part I  of Schedule  VI of\t the Statute. In the
\nstatutory form\tthere are  various heads  including heads of
\nvarious kinds  of reserves  and also  of provisions.  In the
\nbalance sheet  of the  Company which  has  necessarily\tbeen
\nprepared in  accordance with  the provisions  of the statute
\nand in\tthe form  prescribed, the  amount recommended by the
\nBoard for  payment of dividend has been shown under the head
\nprovisions and\tnot under  any head  of reserves.  It is, no
\ndoubt, true that the true nature and character of the sum so
\nset apart must be determined with regard lo the substance of
\nthe matter.  The substance  of the matter clearly appears to
\nbe that\t the amount  is set  apart for\tpayment of  dividend
\nrecommended by the Board to be paid to the share-holders and
\nthe said amount is never intended to constitute a reserve of
\nthe Company.  Indeed a\tprovision is made for payment of the
\nsaid amount  to the  share-holders by way of dividend on the
\nbasis of the recommendation made by the Directors. Though in
\nlaw the\t recommendation made by the Directors for payment of
\ndividend to  share-holders does not create any liability for
\nthe payment  of dividend  and liability only arises when the
\nshareholders accept  the said  recommendation, and though in
\nlaw it\tmay be\topen to\t the Board to modify or withdraw the
\nrecommendation with regard to the payment of dividend before
\nthe acceptance\tby the share-holders and it may also be open
\nto the\tshare-holders not  to accept the said recommendation
\nin its\tentirety and  to modify\t the same, yet, for business
\npurposes, when\tthe directors  make any\t recommendation\t for
\npayment of dividend and set apart any amount for the payment
\nof dividend so recommended, the directors intended to make a
\nprovision for  the payment  of dividend\t recommended by them
\nand not\t to create  any reserve,  as the Directors very well
\nknow that the recommendation made by them with regard to the
\npayment of  dividend is\t not normally  up-set by  the share-
\nholders and  it is  generally accepted by the share-holders,
\nas a matter of course. Any amount set apart by the Directors
\nfor payment  of dividend to the share-holders recommended by
\nthem, is  understood by persons interested in company and in
\ndealing with  companies to  mean a provision for the payment
\nof dividend  to the  share-holders and\tis not understood to
\nconstitute a  reserve. In  my opinion,\tthis true nature and
\ncharacter of  the sum  so set  apart are  reflected  in\t the
\nprovisions of the Companies Act and more particularly in the
\nmanner of preparation of the balance-sheet of the Company. I
\nam, therefore,\tof the opinion that the amount set apart for
\nthe payment
\n835<\/span>
\nof any\tproposed dividend on the basis of the recommendation
\nof A the Directors cannot constitute reserve for the purpose
\nof computation\tof the capital of the Company. The view that
\nI have\ttaken, to  my mind, appears to be in accord with the
\nview earlier  expressed by  this Court\tin the\tdecisions to
\nwhich I have already referred.\n<\/p>\n
     On the  other questions, I entirely agree with the view
\nexpressed by  my learned brother Tulzapurkar, J. and I agree
\nwith the order proposed by him.\n<\/p>\n
\t  C.A. No. 1614(NT)\/78, Review Petition
\nNo. 57180 and Tax Reference Cases
\nNos 2&3\/77 and 5\/1978 dismissed.\n<\/p>\n
P.B.R.\t\t\t     C.A. No. 860\/73 partly allowed.\n836<\/span>\n\n\n\n<\/pre>\n","protected":false},"excerpt":{"rendered":"
Supreme Court of India Vazir Sultan Tobacco Co. Ltd. Etc. … vs Commlssioner Of Income-Tax … on 25 September, 1981 Equivalent citations: 1981 AIR 2105, 1982 SCR (1) 789 Author: V Tulzapurkar Bench: Tulzapurkar, V.D. PETITIONER: VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC. Vs. RESPONDENT: COMMlSSIONER OF INCOME-TAX ANDHRA PRADESH, HYDERABAD DATE OF JUDGMENT25\/09\/1981 BENCH: […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_lmt_disableupdate":"","_lmt_disable":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[30],"tags":[],"class_list":["post-48844","post","type-post","status-publish","format-standard","hentry","category-supreme-court-of-india"],"yoast_head":"\nVazir Sultan Tobacco Co. Ltd. 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