Punjab-Haryana High Court
Commissioner Of Income-Tax vs State Bank Of Patiala on 27 July, 1992
Equivalent citations: [1993]203ITR150(P&H)
JUDGMENT N.K. Sodhi, J.
1. These are four references under Section 256(1) of the Income-tax Act, 1961 (hereinafter referred to as "the 1961 Act"). They arise out of a common statement of case submitted by the Income-tax Appellate Tribunal, Chandigarh Bench, and, hence, are being disposed of by one judgment. The assessment years with which we are concerned in these references are 1971-72 to 1975-76. The two questions referred to us for our opinion are as follows :
"(i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the amounts provided by the assessee for bad and doubtful debts in the balance-sheets of the relevant previous years qualified as reserves for the purpose of Clause (xi)(b) of Rule 1 of the First Schedule to the Companies (Profits) Surtax Act, 1964, and consequently, allowing yearwise deduction as under :
Rs.
1971-72 7,00,000 1972-73 13,78,000 1973-74 22,11,000 1975-76 15,98,000
(ii) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the amounts of Rs. 10,53,576, Rs. 27,21,641, Rs. 29,91,641 and Rs. 47,16,641 provided for bad and doubtful debts as at the beginning of the relevant accounting year respectively for the assessment years 1971-72, 1972-73, 1973-74 and 1975-76 qualified as a reserve for inclusion in the capital of the assessee under the Second Schedule to the Companies (Profits) Surtax Act ?"
2. The sole point which requires determination for answering both these questions is whether the amounts set apart by the assessee during each assessment year for bad and doubtful debts in the balance-sheets of the relevant periods constitute a "reserve" as contemplated under Rule l(xi)(b) of the First Schedule and Rule l(iii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964 (hereinafter called "the 1964 Act").
3. The 1964 Act imposes a special tax on the profits of certain companies. Under Section 4 of this Act, there shall be charged on every company for every assessment year commencing from April 1, 1964, a tax called surtax in respect of so much of its chargeable profits of the previous year as exceeds the statutory deduction at the rates specified in the Third Schedule. The terms "chargeable profits" and "statutory deduction" have been defined in Clauses (5) and (8), respectively, of Section 2 of the 1964 Act and they read as under :
"(5) 'chargeable profits' means the total income of an assessee computed under the Income-tax Act, 1961 (43 of 1961), for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule.
(8) '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 :
Provided that where the previous year is longer or shorter than a period of twelve months, the aforesaid amount of ten per cent. or, as the case may be, of two hundred thousand rupees shall be increased or decreased proportionately :
Provided further that where a company has different previous years in respect of its income, profits and gains, the aforesaid increase or decrease, as the case may be, shall be calculated with reference to the length of the previous year of the longest duration. ..."
4. From the above definitions, it would be seen that net chargeable profits have to be arrived at by making certain adjustments by excluding certain sums from the total income as computed under the 1961 Act in accordance with the Rules contained in the First Schedule. Similarly, the capital of a company has to be computed in accordance with Rule 1 contained in the Second Schedule to the 1964 Act which is the aggregate of the amounts mentioned therein for the purpose of determining the statutory deduction. Rule l(xi)(b) in the First Schedule and Rule l(iii) in the Second Schedule which are relevant for our purpose are reproduced hereunder :
"Rule 1 of the First Schedule.--Income, profits and gains and other sums falling within the following clauses shall be excluded from such total income, namely :--....
(xi) in the case of a banking company--. . . .
(b) any sum transferred by it during the previous year to any reserves in India including reserves not shown as such in its published balance-sheet in so far as the sums transferred to such reserves are attributable to income chargeable to tax under the Income-tax Act and have not been allowed as a deduction in computing its total income under that Act, and in so far as the aggregate of such sums does not exceed the highest of the aggregate of such sums, if any, so transferred during any one of the three years prior to the previous year, whichever is higher. . . .
Rule 1 of the Second Schedule.--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 (11 of 1922), or the Income-tax Act, 1961 (43 of 1961)."
5. During the course of the assessment proceedings under the 1964 Act, the assessee herein which is a banking company claimed the following amounts mentioned against the relevant assessment years as deductions from its chargeable profits since such amounts had been set apart by it in the relevant balance-sheets for bad and doubtful debts ;
Rs.
1971-72 7,00,000 1972-73 13,78,000 1973-74 22,11,000 1975-76 15,98,000
6. The plea was that the allocation under this head was a "reserve1" within the meaning of Clause (xi)(b) of Rule 1 of the First Schedule to the 1964 Act. The assessee also claimed the following amounts mentioned against the respective assessment years for inclusion in its capital so that the same could be deducted as "statutory deduction" from its chargeable profits for the purpose of surtax, the basis of this claim being the same, namely, the amounts earmarked were "reserves" within the meaning of Clause (iii) of Rule 1 of the Second Schedule :--
Rs.
1971-72 10,53,576 1972-73 27,21,641 1973-74 29,91,641 1975-76 47,16,641
7. These amounts had been set apart for bad and doubtful debts as at the beginning of the relevant accounting year. The Surtax Officer did not agree with the assessee as, according to him, all these items were in the nature of a "provision" and were not covered by the definition of "reserve " and, therefore, these were neither eligible for deduction under Rule 1(xi)(b) of the First Schedule nor could they enter into the computation of capital under the Second Schedule to the 1964 Act. The matter was taken up in appeal before the Appellate Assistant Commissioner of Surtax, Patiala, who, while agreeing with the Surtax Officer, held that the reserve for bad and doubtful debts was not a "reserve" within the meaning of Rule 1(xi)(b) of the First Schedule and Rule 1(iii) of the Second Schedule and that it was a "provision". The appeal was dismissed. A second appeal was then filed before the Income-tax Appellate Tribunal. The assessee's case before the Tribunal was that in its unpublished balance-sheets the amounts mentioned hereinabove had been shown as "reserves" though in the published balance-sheets the amounts had been shown as a "provision". It was contended on behalf of the assessee before the Tribunal that a banking company was entitled to have an unpublished balance-sheet as well which is recognised by law and reference in this regard was made to Section 34A of the Banking Regulation Act, 1949. As regards the second question referred to us, the assessee submitted before the Tribunal that its case was in pari materia with the facts of the case decided by the Tribunal in the case of Punjab State Small Industries Corporation Ltd., Chandigarh, and since the Tribunal in that case had held that the amounts set apart for bad and doubtful debts were "reserves", these were to be held as "reserves" in the case of the assessee as well. The Tribunal while accepting the contentions of the assessee allowed the appeal and recorded the following findings :
"We also find that no amount on account of bad debts was factually written off or adjusted by the assessee against these amounts claimed as reserves, that in fact the assessee also did not make a claim for any deduction for any of the assessment years under consideration on account of bad debts, that no such claim was either made or allowed by the Income-tax Officer, that the assessee made contra entries in the unpublished balance-sheets only and no such entries were passed in books and that the published balance-sheets did not contain any contra entries. The amounts were in fact treated as reserves. ..."
8. While dealing with the second issue, the Tribunal referred to the earlier case decided by it and relied upon by the assessee and observed as under:
". . . . The facts on the second issue before us are in pari materia with that case. ..."
9. On reference applications filed by the Revenue, the Tribunal referred the aforesaid two questions of law for our opinion.
10. Before coming to the real issue as to whether the amounts set apart by the assessee in its balance-sheets constitute a "reserve" or a "provision", let me first dispose of an ancillary issue as to whether a banking company can at all have an unpublished balance-sheet as has been found by the Tribunal. As would be seen from the order of the Tribunal, reliance in this regard was placed on the provisions of Section 34A of the Banking Regulation Act, 1949. Mr. R.P. Sawhney, learned counsel for the Revenue, strongly contended before us that neither Section 34A nor any other provision of law recognises an "unpublished balance-sheet" of a banking company and the conclusion arrived at by the Tribunal was based upon its own imagination and the inference drawn from Section 34A was wholly unwarranted. He submitted that there was no recognised practice in the banking circles in India whereby the banks prepare unpublished balance-sheets which are different from published balance-sheets nor has any statutory recognition been given to unpublished balance-sheets. Despite the fact that this point was strenuously urged before us on behalf of the Revenue and almost conceded by learned counsel appearing on behalf of the assessee, we find no subtance in the same.
11. There was a long standing practice in England of banking companies, as distinguished from companies carrying on other business, not to disclose in their balance-sheets and the profit and loss account, bad and doubtful debts and the provision made therefor as well the secret reserves created and held under various items. This practice was followed by several banks in India and the question arose from time to time as to how far the practice was consistent with the statutory provisions requiring the balance-sheet of a company to "give a true and fair view of the state of affairs of the company" contained in the several Companies Acts enacted from time to time. The desirability and even the legality of this practice has not gone without challenge and there are many of the opinion that this is salutary and necessary for the preservation and progress of a credit institution like a bank. Section 34A of the Banking Regulation Act, 1949, was inserted by Parliament by Act No. 23 of 1960, and its constitutional validity in the wake of the practice prevalent in India came to be challenged before the apex court. While examining the constitutional validity of this provision, their Lordships of the Supreme Court in All India Bank Employees' Association v. National Industrial Tribunal [1962] 32 Comp Cas 414 ; AIR 1962 SC 171, outlined very lucidly the history of the steps which led to the enactment of this provision and noticed the practice that banks do have undisclosed or secret reserves which they acquire in a number of ways and such undisclosed reserves cannot be ascertained from the published balance-sheets. Even the provision pertaining to bad and doubtful debts cannot some time be discovered. It is true that balance-sheet of every company is required to give a "true and fair view of the state of affairs of that company" at the end of the financial year as provided in Section 211 of the Companies Act, 1956. However, Section 34A of the Banking Regulation Act has given statutory recognition to the maintenance of secret accounts by banking companies. While judicially recognising the practice of banking companies having secret accounts which are not reflected in their published balance-sheets, the object of this enactment was summed up by their Lordships of the Supreme Court in the aforesaid case as follows (at page 422 of 32 Comp Cas) :
"The foregoing narrative would show that the Banking Companies Act, as it stood before the amendment now challenged, had brought the law as to the disclosure of secret reserves and the provision for bad and doubtful debts, etc., into accord with the usual practice of bankers, and had protected these items from being compulsorily disclosed to the shareholders of the respective companies and to the general public. There had been a controversy as to whether the workmen of these establishments were or were not entitled to be placed on a different position from the shareholders because of the bearing of these undisclosed items on the determination of the quantum of their wage, etc., and on their conditions of work having financial implications. Parliament had, by the impugned legislation, extended the protection from compulsory disclosure to the workmen as well, but with a safeguard in their case that the Reserve Bank would determine the amount of reserves, etc., which could be taken into account in the course of industrial adjudication. ..."
12. From the aforesaid observations and the history which led to the enactment of Section 34A, we are of the view that the banking companies maintain secret reserves in many forms which may not be disclosed in their published balance-sheets--whether we may call them unpublished balance-sheets or record of secret reserves, as also the record showing provision for bad and doubtful debts and other usual and necessary provisions, the fact remains that the practice referred to by the Tribunal does exist in banking circles.
13. Now, I shall deal with the real issue as to whether the fund created for bad and doubtful debts was a "reserve" or a "provision". The expression "reserve" has not been defined in the 1964 Act and the dictionary meanings of both the words are more or less synonymous and are not of much help in bringing out the distinction though the distinction is fairly well known in commercial accountancy. Since the term "reserve" occurs in a taxing statute which is applicable to companies only and to no other class of assessees, as such it will have to be understood in its ordinary popular sense, namely, the sense and meaning that is attributed to it by men of business, trade and commerce and by persons interested in and dealing with companies. The intention of those who are authorised to treat an amount as a reserve or a provision is sometimes material. This matter came up for consideration before their Lordships of the Supreme Court in Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 53, where the distinction between the two concepts was brought out in the following words (at page 67) :
"The distinction between a provision and a reserve is in commercial accountancy fairly well-known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made whereas general reserves and reserve funds are shown as part of the proprietor's interest (see Spicer and Pegler's Book Keeping and Accounts, 15th Edition page 42). An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision (see William Pickles Accountancy, Second edition, page 192 ; Part III, Clause 7, Schedule VI to the Companies Act, 1956, which defines provision and reserve)."
14. This test has been subsequently followed by their Lordships of the Supreme Court in Vazir Sultan Tobacco Co. Ltd. v. CIT (1981] 132 ITR 559. In CIT v. Elgin Mills Ltd. [1986] 161 ITR 733, it was held by the Supreme Court that in respect of bad and doubtful debts, whether the account could be treated as reserve or provision would depend upon the facts and circumstances of the case.
15. The broad distinction between the two concepts is that whereas a provision is a charge against the profits to be taken into account against gross receipts in the profit and loss account, a reserve is an appropriation of profits to provide for an asset which it represented. It is by now well-settled that in order to determine the true nature and character of the sum set apart, regard must be had to the substance of the matter and not the form. While reiterating these tests the Supreme Court in CIT v. Saran Engineering Co. Ltd. [1986] 161 ITR 741, observed at page 748 as under:
"It may be mentioned that where the liability has actually arisen or is anticipated legitimately by the assessee though the quantum of the liability has not been determined, a fund to meet such present liability cannot be treated as 'reserves'. A fund, however, created for payment of a liability which had not already arisen or fallen due but is only a provision with regard to the sum that might become liable to be paid is 'other reserves' within the meaning of Rule 1 of the Second Schedule and should be taken into account in computing the capital of the company for the purpose of the Companies (Profits) Surtax Act, 1964."
16. Thus, where a fund has been created to meet a liability which has actually arisen and is known on the date of the preparation of the balance-sheet, it would obviously be a provision. Again, a fund created or a sum of money set apart to meet any liability which the assessee can reasonably and legitimately anticipate on the date of preparation of the balance-sheet though the quantum of that liability is not yet determined, has also been equated with a present known liability and the fund to meet such liability cannot be treated as a reserve. If, on the other hand, a fund is created to meet some future unknown liability which has not yet arisen and which could not legitimately and reasonably be anticipated by the assessee at the time of the preparation of the accounts, the fund would be treated as a "reserve". Whether in respect of bad and doubtful debts, an account could be treated as a reserve or a provision would depend upon the facts and circumstances of each case. Again, whether a particular liability could reasonably and legitimately be anticipated by the assessee on the date of the balance-sheet would be a question of fact to be determined in the circumstances of each case and the nature of the business carried on by the assessee would be a relevant factor.
17. Applying these tests to the case in hand, one cannot lose sight of the fact that the assessee before us is a banking company whose primary business is to lend money. In the very nature of things, it would be reasonable and legitimate for such an assessee to assume that in the course of its business, it is bound to have bad and doubtful debts, for which it may in anticipation make a provision in the balance-sheet by having a separate fund or an account to meet such anticipated liability although its quantum would be determined at some later date. Since such anticipated liability has been equated with a known and existing liability, the fund is to be considered a "provision" and not a "reserve". There can be no dispute about the principle that if a provision for a known and existing liability is made in excess of the amount that is reasonably necessary for the purpose, it would be a "reserve" and, therefore, includible in the capital computation. We cannot accept the contention of the assessee that bad and doubtful debts in the case of every company must necessarily be treated as reserves within the meaning of the Companies (Profits) Surtax Act. Counsel cites CIT v. Jyoti Ltd. [1978] 112 ITR 973 (Guj), Addl. CIT v. Indian Telephone Industries [1979] 118 ITR 291 (Kar), CIT v. Karam Chand Thapar and Brothers [1981] 131 ITR 175 (Cal), K. Subramanian v. Siemens India Ltd. [1988] 173 ITR 136 (Bom) and CIT v. Andhra Bank Ltd. [1980] 186 ITR 192 (AP), in support of his contention. We are afraid that none of these decisions supports the contention of the assessee.
18. In CIT v. Jyoti Ltd. [1978] 112 ITR 973 (Guj), the assessee was not a banking company and the reserve for doubtful debts was not created with a view to meeting any anticipated or known existing liability, and, therefore, it was included in the computation of the capital base. This judgment is, therefore, of no help in the instant case.
19. Indian Telephone Industries' case [1979] 118 ITR 291 (Kar), was again the case of a non-banking company where the question of a liability being reasonably and legitimately anticipated by the assessee did not come up for consideration before the learned judges. Since the reserve for bad and doubtful debts in this case was not in regard to any known liability on the date of the balance-sheet, it was held to be a "reserve".
20. The point before us did not arise in CIT v. Karam Chand Thapar and Brothers [1581] 131 ITR 175 (Cal), in which it was held that the reserve for bad and doubtful debts was far in excess of such debts and the extent to which it was in excess was treated as a reserve includible in computing the capital base of the company.
21. Strong reliance was placed on the decision of the apex court in CIT v. Saran Engineering Co. Ltd. [1986] 161 ITR 741 to contend that bad and doubtful debts "reserve" must be treated as a reserve. In that case a reserve for this purpose was created in 1956 through the profit and loss appropriation account. Further, a separate provision had been made for bad and doubtful debts which provision was reduced from the value of the assets and it was not the Revenue's case that the provision for bad and doubtful debts provided was less than the amount reasonably necessary to be provided. It was in these circumstances that the bad and doubtful debts "reserve" created in 1956 was treated as a "reserve". This is not so in the instant case. This decision of the apex court rather supports the case of the Department as has been discussed in the earlier part of this judgment.
22. In Siemens India Ltd.'s case [1988] 173 ITR 136 (Bom), both a reserve and a provision had been made for bad and doubtful debts which were not meant to be utilised for writing off bad and doubtful debts and that such debts were invariably being debited to the profit and loss account. It was in these circumstances that the learned judges of the Bombay High Court held both the provisions as "reserves". Moreover, this is not a case of a banking company and the question whether a liability could reasonably and legitimately be anticipated by the assessee was not gone into.
23. CIT v. Andhra Bank Ltd. [1990] 186 ITR 192 (AP), is no doubt a case pertaining to a banking company but the sums set apart by the assessee in that case to meet bad and doubtful debts were held to constitute "other reserves" because the assessee had separately ascertained the debts which had actually become bad and debited the same to the profit and loss account and the fund so created was allowed to remain intact. It was in such circumstances that the sums set apart were treated as "reserves".
24. It was also urged on behalf of the assessee that the intention of those who were dealing with the fund for bad and doubtful debts, namely, the board of directors of the company, was material and since they had described the same as a "reserve" in the unpublished balance-sheets (as the Tribunal calls it) or in its secret and unpublished accounts, the same should be treated as "reserve". It is true that the fund was shown as a reserve in the unpublished account but in the published balance-sheets for the relevant years, the amount was described as a provision and even the board of directors in their 66th meeting held at New Delhi approved it as a "provision" to be appropriated out of profits and not as a "reserve". It is, thus, clear that the intention of the board of directors was to treat the fund as a provision no matter that it had been mentioned as a reserve in the unpublished and secret accounts of the company.
25. As regards the second question, we are of the opinion that the Tribunal was in error in holding that the facts of the present case were in pari materia with the case of Punjab State Small Industries Corporation Ltd. on which reliance was placed on behalf of the assessee. As is clear from the order of the Tribunal in the case, the Revenue had accepted in the previous years, the fund for bad and doubtful debts as a "reserve" and it was only when it wanted to change its stand in the subsequent year that the Tribunal held that the same should continue to be treated as a "reserve". In the case before us, the Department never treated the fund as a reserve in the previous years. Moreover, the Punjab State Small Industries Corporation was not a banking company and the question of its having reasonably and legitimately anticipated bad and doubtful debts did not arise.
26. For the reasons recorded above, we are of the view that on the facts and circumstances of the present case, the sums of money set apart by the assessee herein for meeting its anticipated liability were a "provision" and the Tribunal erred in law in holding them to be a "reserve". In the result, both the questions referred to us are answered in the negative, i.e., against the assessee and in favour of the Revenue. The reference is answered accordingly. The parties shall bear their own costs.