Karnataka High Court
Commissioner Of Income-Tax vs Eskayef Ltd. on 18 April, 2007
Equivalent citations: (2007)211CTR(KAR)31, [2008]296ITR110(KAR), [2008]296ITR110(KARN)
Bench: R. Gururajan, Anand Byrareddy
JUDGMENT
R. Gururajan and Anand Byrareddy, JJ.
Page 1606
1. This reference is at the instance of Commissioner of Income-tax.
2. Assessment under Section 16(2) of the Companies (Profits) Sur-tax Act, 1954 was made on the basis of return of chargeable profits furnished by the assessee based on the United Kingdom accounts. In the assessment so made, the amount of capital was taken as declared by the assessee. The Commissioner subsequently found that the capital so declared and accepted by the Assessing Officer was erroneous and prejudicial to the interests of Revenue in so far as the inclusion in the 'capital' of (i) reserve representing unappropriated profits in the United Kingdom account and (ii) reserve equivalent to the capital expenditure on scientific research which expenditure was allowed while computing the income under the Income-tax Act was concerned. The Commissioner, by using his powers Under Section 16(2) of the Sur-tax Act, accordingly set aside the assessment and restored it to the Assessing Officer to frame it afresh excluding similar reserves in the Indian accounts of the assessee from the computation of capital. The Assessing Officer reframed the assessment in accordance with the Commissioner's directions. The assessee's appeal against the reassessment was dismissed by the Commissioner (Appeals) on the ground of non-maintainability. The assessee had also preferred appeal before the Tribunal against the order of the Commissioner. The tribunal in its consolidated order dt.17.12.1993 in STA Nos. 8, 9, 10 & 11/Bang/1988, reported at 49 ITD 207, allowed the appeal holding that the Commissioner had no jurisdiction to try to revise the assessment order by resorting to his powers Under Section 16(2) since the said order passed by the Assessing Officer could not be considered to have been erroneous and prejudicial to the interests of revenue.
3. The revenue thereafter in the light of an adverse order of the tribunal, moved a reference application and the same was considered in terms of the reference made to us. The tribunal has now framed the following two questions of law for our consideration.
Whether, on the facts and in the circumstances of the case, particularly in view of the Explanation below Rule 1 of Second Schedule to the Companies (Profits) Sur-tax Act, 1964 alongwith the provisions of Rule 1A of the said Schedule, the Tribunal was correct in law in holding that 'unappropriated profits' shown in the P&L accounts of the Head-office of the assessee-company at United Kingdom cannot be excluded from the 'capital' to be computed for the purpose of sur-tax assessment?
Page 1607
(ii) Whether, on the facts and in the circumstances of the case, particularly in view of the provisions of Sub-rule (iii) of Rule 1 of the Second Schedule to the Companies (Profits) Sur-tax Act, 1964, the Tribunal was correct in law in holding that the capital expenditure on scientific research as appearing in the United Kingdom accounts of the company cannot be considered to have been allowed as deduction in computing the income of the company for income-tax purposes and consequently in allowing the claim of the asses see that such amount of expenditure forming part of the "reserves" cannot be excluded from, the "capital" to be computed for the purpose of sur-tax assessment?
4. Heard Sri Seshachala, learned Counsel appearing for the revenue. He would take us through the relevant case laws to say that the tribunal is wrong in considering the case of the assessee in terms of the impugned order. He would argue that the findings of the commissioner require our interference and we should answer the questions in favour of the revenue. In so far as the second item is concerned, learned Counsel would again take us through the material on record and the relevant provisions to say that the tribunal is not justified in passing an adverse order against the revenue. Per contra, Sri Sarangan, learned senior counsel would support the order.
5. After hearing, we have carefully perused the material on record. Our answers are as under;
Regarding Question No. 16. Question No. 1 deals with the findings of the tribunal with regard to the unappropriated profits shown in the P & L Account of the Head profits shown in the P & L Account of the Head Office of the assessee. The tribunal has ruled that the said amount cannot be excluded from the 'capital' to be computed for the purpose of sur-tax assessment. To consider this question, one has to notice the facts available on record. An assessment order was passed and in the assessment order the amount of capital was taken as declared by the assessee. Subsequently, the Commissioner found that the capital so declared and accepted by the assessing officer was erroneous and prejudicial to the interest of revenue and in that view of the matter, he set aside the assessment order and directed the assessing officer to frame it afresh. The assessing officer reframed the assessment in accordance with the commissioner's direction. When the said order was challenged before the tribunal, the tribunal has chosen to accept the case of the assessee. Let us see as to whether the tribunal is justified in so far as this question is concerned in terms of its findings. From the facts it is seen that the assessing officer has chosen to rely on Sub-clause (iii) of Rule 1 of II Schedule for the purpose of passing an adverse order against the assessee. When an appeal was filed. The appeal stood dismissed. The tribunal in the second appeal would notice the issue of computation of capital base for the purpose of charging the assessee to Sur-tax. At this stage Schedule VI form of balance sheet submitted Page 1608 by the assessee is to be seen. The assessee at page 3 of the balance sheet would say as under in so far as 'reserves and surplus' are concerned;
1. Capital reserves
2. Capital Redemption Reserve
3. Share premium Account (cc)
4. Other Reserves specifying the nature of each reserves and the amount in respect thereof.
Less: Debt balance in profit and loss account (if any)(h)
5. Surplus, i.e., balance in profit and loss account after providing for proposed allocations, namely-, Dividend, Bonus or Reserves.
6. Proposed additions to reserves.
7. Sinking Funds.
6. The Companies (Profit) Sur-tax Act Under Section 2A defines the statutory deduction meaning an amount equal to 15% of the Capital of the Company as computed in accordance with the provisions of the second schedule, or an amount of two hundred thousand rupees, whichever is greater. The Rules provide for computing the capital of a company for the purposes of Surtax. A reading of Rule 1 of the second schedule would show that subject to other provisions contained in the schedule the capital of the company shall be aggregate of the amounts, as on the first day of the previous year relevant to the assessment year. Sub-clause (iii) with which we are concerned would read as under;
(iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the India Income-tax Act, 1922 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961).
7. An explanation reading as under is also provided to the Rule of the Second Schedule.
For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the 1st day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the heading RESERVES AND SURPLUSES' or of any item under the heading 'CURRENT LIABILITIES AND PROVISIONS' in the column relating to 'Liabilities' in the 'form of balance sheet' given in Part I of Schedule VI of the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this schedule.
8. Hence what is clear to us is that the explanation makes it clear that items 5, 6 and 7 are not to be regarded as a reserve for the purpose of computation of a capital of a company. The authorities have, in the light of explanation have chosen to reject the case of the assessee. The tribunal in its order would notice the material facts for the purpose of consideration Page 1609 of the case of the assessee. When a notice was issued, the appellant has chosen to submit an explanation to the notice issued. In the explanation, the assesses would plead that although in India it is not possible to treat unappropriated mass of profit as a part of 'reserve' for the purpose of computation of capital base, in UK Companies Act and generally accepted UK accounting practice, the retained profit at the end of each year is carried forward as a reserve and that as the accumulated balance on the profit and loss account itself forms a part of the reserve, there is no requirement for a formal resolution of the directors of share holders to transfer an amount to reserves in order for it to become 'reserves'. It has been stated that this treatment is similar to that adopted under USA generally accepted accounting practice where by the undistributed profits of each year are added to 'reserves' and are carried forward from year to year within reserves. Learned Judge after noticing this aspect of the matter notices the letter dtd 7-10-1991. After noticing the letter and the contention of the asseasee, the tribunal would hold in para 6 of the impugned order that even when we look at the UK accounts of the assessee-company, we find that the above mentioned version of the auditors of the assessee-company appear to be very much true. The balance sheet of the company shows only other reserves in addition to investment allowance and development rebate reserves. The breakup of this other reserve alone shows the component items like unappropriated profits brought forward and reinstatement of capital expenditure on scientific research. Like India, the unappropriated mass of profit is not shown as a separate entity until the said mass is converted into reserve by a resolution of the Board of Directors or of the shareholders of the assessee. It thus appears that the 'earned surplus'. 'Unappropriated profits' etc., by whatever name the surplus of profit be called, thus automatically forms a part of other reserves at the end of the year. Since we are concerned with the position as prevailing on the first day of the next accounting year, what we are confronted with is only a single items via., 'other reserves' which, according to us, therefore is surely to be considered as a reserve to be included within the capital base of the company. Hence, we find no reason to exclude either the inappropriate profits as appearing in the UK accounts of the company of the surplus profit and loss account as appearing in its Indian Accounts from the capital base.
9. From the order of the tribunal what is clear to us is that the tribunal has chosen to accept the case of the assessee in the light of the accounting practice both in UK and USA and in the light of the letter dtd 7-10-1991. The order of the tribunal in our view is based on facts. For want of approval by way of Board Resolution, the same is shown as Reserves and Surplus. The said explanation is neither denied nor doubted by the department. In these circumstances, it cannot be said that the tribunal has committed any error whatsoever. Therefore we deem it proper to accept the order of the tribunal in this regard. No exception can be taken to this finding recorded by the tribunal. After all the nomenclature cannot by itself decide the issue. When the said nomenclature has been properly explained the tribunal has to Page 1610 consider the case and pass appropriate orders for consideration in terms of Rule 1(iii) of the Explanation. We accept the finding of the tribunal.
11. The Supreme court in the case of (1961) 42 ITR 17 has considered a similar issue and ultimately ruled as under;
The creation and maintenance of the item known 'undivided profits' was a requirement of the Treasury Rules which were made under the statute and, therefore, it could not be said that the amount of 'undivided profits' in the balance sheet was not allocated as a result of either a resolution of the directors, accepted by the shareholders, or on account of the requirements of the law. Therefore, the amount designated as 'undivided profits' was a part of the reserves and had to be taken into account when computing the capital and reserves under Rule 2(I) of Schedule II to the Business Profits Tax Act.
11. The tribunal has noticed this judgment in support of its finding. We accept the findings of the tribunal.
Regarding Question No. 2Question No. 2 is with regard to capital expenditure on scientific research as appearing in the United Kingdom accounts of the company. Here again, both the assessing officer and the appellate commissioner have rejected the case of the assessee. The tribunal has passed an order in favour of the assessee. Let us see as to whether finding of the tribunal on this issue can be accepted or not. The tribunal notices its earlier order for the assessment year 1976-77 and 1977-78 and after noticing the same the tribunal holds that it is only obiter and that therefore it differs from the said decision. It holds that the amounts representing capital expenses on scientific research cannot be considered to have been allowed as a deduction in computing the income of the company for the Income Tax Act. We further see from the order of the tribunal that the tribunal notices the material facts and from the material facts, we see that the general entry which is made by all assessees with regard to expenses of this type is as below;
Debit asset account (on scientific reasearch) Credit cash or bank account.
12. In addition to the above entry, the assesses appears to have passed another entry also as below;
Debit profit and loss account and Credit, general reserve account.
13. After noticing these two entries, the tribunal comes to a conclusion that what has been allowed in computation of the income of the assessee for income tax purpose is the amount debited to the asset account which alone represents the expenditure in this regard in respect of which cash or bank money has been spent. It was not necessary for the assessee to pass the second entry but this second entry seems to have been passed for the Page 1611 sake of creating the reserve in this regard separately. The capital expenditure on scientific research is allowed as deduction in computation of the total income of the assessee separately in accordance with the provisions of Section 35 and it was not at all necessary for the assessee to debit this amount separately in accordance with the provisions of Section 35 and it was not at all necessary for the assessee to debit this amount separately to the profit and loss account. The creation of reserve corresponds to the debit made to the profit and loss account which item cannot at all be considered to have been allowed as deduction in as much as we have seen just now that even inspite of lack of this second entry, the first entry alone however suffices the purpose of the assessee claiming the deduction. Simply because of the fact that the amounts involved in both these entries are the same, it cannot be said that the amount credited to the reserve account in this regard has been allowed as deduction in computing the income of the assessee. We thus fully support the view of the assessee that the reserve artificially created on account of capital expenditure on scientific research is also to be considered as reserve and again is not be excluded from the computation of capital of the assessee in accordance with the provisions of Sub-clause (iii) of Clause (I) of II Schedule. Ultimately, the tribunal comes to a conclusion that because of inclusion of surplus (corresponding to reinstatement profits in the UK accounts) and of general reserve (corresponding to reinstatement of capital expenditure on scientific research in the UK account) within the computation of capital base of the assessee-company for all the four years under consideraton.
14. We are totally not in agreement with the findings of the tribunal. The tribunal virtually seems to make a ease for the company. When there is second entry in the reserve account, that entry has to be noticed for the purpose of a finding. In the case on hand, in the light of the Explanation. It is not open to the tribunal to give certain other findings by way of 'artificial reserve', 'special reserve' etc., without any basic foundation for the same. Sri Seshachala, learned Counsel is therefore justified in arguing that this finding as unsustainable. In the light of the Explanation to Rule (I) (iii) and in the light of the special entry available with reference to the reserve, we are inclined to answer this question in favour of the revenue.
15. In the result, this reference is partly accepted. The first question of law is answered in favour of the assesses and the second question of law is answered in favour of the revenue.
Ordered accordingly. No costs.