Kerala High Court
Commissioner Of Income-Tax vs Travancore Electro Chemical ... on 9 April, 1987
Author: T. Kochu Thommen
Bench: T. Kochu Thommen
JUDGMENT T. Kochu Thommen, J.
1. The following two questions have been referred to us by the Income-tax Appellate Tribunal, Cochin Bench :
"(1) Whether, on the facts and in the circumstances of the case, and having regard to the memorandum of agreement dated November 25, 1965, the Tribunal was right in law in holding that the capital reserves of Rs. 5,17,905 and Rs. 4,86,696 for the assessment years 1972-73 and 1973-74 respectively were brought into existence by creating or increasing (by revaluation or otherwise) the book assets, and that, therefore, such reserves cannot be taken as forming part of the paid up capital for the purpose of computing the capital under the Companies (Profits) Surtax Act, 1964 ?
(2) Whether, on the facts and in the circumstances of the case, a diminution of the capital in proportion to the deduction allowed under sections 80M and 80G of the Income-tax Act is permissible under rule 4 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ? "
2. Question No. 1 has been referred at the instance of the assessee and question No. 2 at the instance of the Revenue.
3. The assessment years are 1972-73 and 1973-74. The assessee is a limited company. Both the questions arise under the Companies (Profits) Surtax Act, 1964, (the "Act"). Question No. 2 has to be answered in the light of the decision of this court in CIT v. Premier Cotton Spinning Mills Ltd. [1981] 128 ITR 694 (Ker), in the affirmative (sic), that is, in favour of the assessee and against the Revenue. We do so.
4. Question No. 1 relates to the assessee's claim for statutory deduction in respect of the amount shown in the capital reserve account of the company. During the accounting year relevant to the assessment year 1966-67, the assessee purchased machinery from a German seller. One of the machines did not work satisfactorily, and the assessee, therefore, received from the seller on December 31, 1966, a total sum of Rs. 6,21,050 as compensation for the defective machine. After writing off certain miscellaneous items of expenditure, the assessee transferred this amount to a capital reserve fund which as on December 31, 1970, stood at Rs. 5,17,905 and as on December 31, 1971, at Rs. 4,86,696. During the respective accounting years relevant to the assessment years in question, the assessee claimed in respect of the said amount the "statutory deduction" in the computation of the capital of the company for the purpose of surtax in accordance with the Second Schedule to the Act. This claim was originally allowed by the Income-tax Officer for both the years. But, subsequently, the assessment was reopened and this amount was disallowed. The Officer found that the amount in question was hit by Explanation 1 to rule 2 of the Second Schedule to the Act. Aggrieved by that order, the assessee appealed and the Appellate Assistant Commissioner allowed the appeal. On appeal by the Revenue, the Tribunal set aside the order of the Appellate Assistant Commissioner and restored that of the Income-tax Officer in so far as it related to question No. 1.
5. We shall now read the relevant provision.
"4. Charge of tax.--Subject to the provisions contained in this Act, there shall be charged on every company for every assessment year commencing on and from the 1st day of April, 1964, a tax (in this Act referred to as 'the surtax)' in respect of so much of its chargeable profits of the previous year or previous years, as the case may be, as exceed the statutory deduction, at the rate or rates specified in the Third Schedule."
6. Statutory deduction is defined under Section 2(B) which says:
" 'statutory deduction' means an amount equal to ten per cent. 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;..."
7. These provisions show that the charge under the Act is only upon the profits in excess of the "statutory deduction". The Second Schedule to the Act which prescribes the method of computing the capital of the company with reference to which the " statutory deduction " has to be determined, provides that the capital of the company shall be the aggregate of the amounts specified under Rule 1 thereof. One of the amounts specified is what is stated under Clause (iii) of Rule 1, which reads:
"1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of--...
(iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (XI of 1922), or the Income-tax Act, 1961 (XLIII of 1961): "
8. Rule 2 contains three Explanations. Explanation I, which is what is relied on by the Revenue, reads :
"Explanation 1.--A paid-up share capital or reserve brought into existence by creating or increasing (by revaluation or otherwise) any book asset is not capital for computing the capital of a company for the purposes of this Act."
9. Is the amount received by the assessee as compensation in respect of the defective machine hit by Explanation 1 to rule 27 ? According to the Revenue, the compensation amount ought to have been shown in the machinery account by reducing the value of the machines by the amount received.
10. The stand of the Revenue, on the present claim of the assessee, appears to be that what was received as compensation was a capital receipt. That is perhaps the correct position. But it would appear that what was received as compensation had been, for the purpose of the levy under the Income-tax Act, treated as revenue and not as capital. It would further appear from the order of the Income-tax Officer that that amount had not been subjected to any deduction by way of depreciation or otherwise. In other words, the compensation amount had all along been treated as part of the taxable income of the assessee.
11. The question then is whether the amount so received as compensation and transferred by the assessee to the capital reserve fund qualifies for deduction under rule l(iii) of the Second Schedule to the Act, or, is it a reserve created "by revaluation or otherwise" of the book assets of the company and thus hit by Explanation 1 to rule 2 of the Second Schedule.
12. Counsel for the Revenue refers to the words "by revaluation or otherwise" and submits that, whether the book assets are revalued or devalued, the reserve brought into existence by transfer of the compensation amount is hit by Explanation 1.
13. It is the common case that Explanation 1 refers to, not a mere book adjustment, but actual transfer of money to a reserve fund. If the compensation amount had been treated as a capital receipt, which in the present case had not been done, that would have been a case of devaluing the book assets relating to the machinery. If that fund had been transferred to a reserve fund, it would have been hit by Explanation 1. But in respect of that fund, in that event, the assessee would not have had any burden under the Income-tax Act, for it would then have been excluded as capital. But strangely enough, that was not what was done. On the facts of this case, it cannot be gainsaid that what was treated as part of the revenue, and included as part of the taxable income, although received as compensation, had been transferred to a reserve fund. That transfer was of money taken out of the assessee's chargeable profits. That money did not represent the book assets. It was not created by revaluation or otherwise of the book assets. It had no relation to any asset, for it was at all material times treated as revenue and charged as such under the Income-tax Act. It was in no way concerned with what is postulated under Explanation 1 to rule 2.
14. In the circumstances, the amount transferred to the reserve fund is a "reserve" within the meaning of Clause (iii) of Rule 1 of the Second Schedule to the Act. Accordingly, we answer question No. 1 in the negative, that is, in favour of the assessee and against the Revenue.
15. We direct the parties to bear their respective costs in these tax referred eases.
16. A copy of this judgment under the seal of the High Court and the signature of the Registrar shall be forwarded to the Income-tax Appellate Tribunal, Cochin Bench.