Bombay High Court
Commissioner Of Income Tax vs Protos Engineering Co. Pvt. Ltd. on 6 October, 1992
Equivalent citations: [1994]207ITR831(BOM)
Author: Sujata Manohar
Bench: B.N. Srikrishna, Sujata V. Manohar
JUDGMENT Smt. Sujata Manohar, J.
1. This reference under s. 256(1) of the IT Act, 1961 pertains to the asst. yr. 1963-64. Two questions have been referred to us for decision at the instance of the CIT. These two questions are :
"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that provision for taxation and proposed dividend constituted reserve and should be included in computing the capital base under the Super Profits Tax Act, 1963 ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the excess book depreciation written off over depreciation allowance under the IT Act, of Rs. 52,567 should be included in the capital base under the Super Profits Tax Act, 1963 ?"
2. The relevant facts are as follows :
For the purpose of determining super profits tax payable under the provisions of the Super Profits Tax Act, 1963, the ITO computed the capital of the respondent-company under the Second Schedule to the Super Profits Tax Act, 1963. In so computing the capital, the ITO excluded (1) provision for taxation amounting to Rs. 8,40,514 and (2) the proposed dividend of Rs. 4,46,875. The ITO also disallowed the claim of the assessee for adding a sum of Rs. 52,567 to the capital base of the company on the footing that it was a reserve. The amount of Rs. 52,567 was the excess of book depreciation written off by the assessee in its profit and loss account over the depreciation which was allowed to the assessee under the IT Act, 1961. In respect of this excess depreciation the Tribunal has stated that the assessee had debited a larger amount of depreciation to the P&L account and had adjusted the value to its fixed assets as shown in the Schedule to the balance sheet accordingly, thus reducing its profit as per its P&L account and its reserves and surplus appearing in the balance sheet. The ITO, however, allowed a smaller amount of depreciation. The excess provision for depreciation in the books of the company was claimed as reserve by the assessee, though it was not so shown in the balance sheet.
3. As far as the first question is concerned, it deals with two items (1) provision for taxation and (2) proposed dividend. In order to decide whether these constitute a reserve and should be added to the capital base of the assessee-company, it is necessary first to examine the relevant provisions of the Super Profits Tax Act, 1963. Under s. 4 of the Act there is charged on every company for every assessment year commencing on and from 1st April, a tax called the super profits tax, in respect of so much of its "chargeable profits" of the previous year as exceeded the "standard deduction". Sec. 2(5) defines the expression "chargeable profits" to mean the total income of an assessee computed under the IT Act, 1961, for any previous year and adjusted in accordance with the provisions of the First Schedule. "Standard deduction" is defined in s. 2(9) to mean an amount equal to six per cent of the capital of the company, as computed in accordance with the provisions of the Second Schedule, or an amount of Rs. 50,000, whichever is greater. Hence, it becomes necessary to look at the Second Schedule which lays down rules for computing the capital of the company for determining this standard deduction.
4. Under cl. (1) of the Second Schedule, the capital of a company shall be the sum of the amounts ..... of its paid up share capital and of its reserve, if any, under the proviso (b) to cl. (vib) of sub-s. (2) of s. 10 of the Indian IT Act, 1922 or under sub-s. (3) of s. 34 of the IT Act, 1961 and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purpose of the Indian IT Act, 1922, or the IT Act, 1961 ........."
5. "Other reserves", therefore, form a part of the capital of the company. We have to consider whether a provision for taxation and proposed dividend form a part of these "other reserves". In the case of Vazir Sultan Tabacco Co. Ltd. vs. CIT , the Supreme Court has considered the difference between a reserve and a provision for the purposes of the Super Profits Tax Act, 1963 or the Companies (Profits) Surtax Act, 1964. While considering cl. (1) of the Second Schedule to the Super Profits Tax Act, 1963 which is similar to the Second Schedule to the Companies (Profits) Surtax Act, 1964, the Supreme Court in Vazir Sultan Tobacco Co. Ltd.'s case said that though the expression "reserve" is not defined, since it occurs in taxing statutes and is applicable to companies only and to no other assessable entities, the expression has to be understood in its popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meanings attached to the words "reserve" and "provision" in the Companies Act, 1956, dealing with the preparation of the balance sheet and the P&L account would govern their construction for the purpose of the Super Profits Tax Act or the Companies (Profits) Surtax Act.
6. In its oft quoted passage the Supreme Court has said, "The broad distinction between the two is that whereas a "provision" is a charge against the profits to be taken into account against gross receipts in the P&L account, a "reserve" is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business". The Supreme Court in this connection followed the judgment of the Supreme Court in the case of Metal Box Co. of India Ltd. vs. Their Workmen and said, "If any retention or appropriation of a sum falls within the definition of "provision" it can never by a reserve, but it does not follow that if the retention or appropriation is not a provision, it is automatically a reserve and the question will have to be decided having regard to the true nature and character of the sum so retained or appropriated ..... When an amount is set aside to meet a known or existing liability it is generally considered as a provision and it cannot be regarded as reserve .... If provision for a known or existing liability is made in excess of the amount that would be reasonable necessary for the purpose, the excess should be treated as a "reserve" and, therefore, would be includible in the capital computation".
7. In this connection the Supreme Court also relied upon the provisions of Schedule VI, Part III of the Companies Act, 1956 to which we will refer a little later, under which any amount retained by way of providing for a known liability would be a provision. But any excess amount so retained should be treated as a reserve and not a provision.
8. In view of these provisions of the Companies Act, the Supreme Court in the above case considered the claim of the assessee in relation to a provision for taxation. The Supreme Court said that the liability for taxation having arisen, the amount which is set apart by the Board of Directors for payment of taxes will have to be regarded as a "Provision" for a known and existing liability. If an excess provision was made for taxation, ordinarily it would have allowed such excess provision to be treated as a "reserve" for the purpose and, therefore, includible in the capital computation of the company. But no such case had been made out by the assessee-company at any stage of the assessment proceedings and, hence, such a plea, which would need investigation into the facts cannot, for the first time, be considered by it.
9. The Supreme Court also considered an amount set apart for proposed dividend. It said that an appropriation made by the Board of Directors by way of recommending a payment of dividend cannot, in the nature of things, be a reserve and the concerned amounts so set apart would have to be excluded from the capital computation.
10. In view of the above position, as far as question No. 1 is concerned, the provision for taxation, in so far as it covers the existing liability of the company is a "provision" and not a "reserve". It would not, therefore, be includible in the capital computation. Any excess amount, however, can be treated as a reserve and would qualify for the purpose of being added to the capital base of the company. The Tribunal is directed to work out the amounts accordingly.
11. As far as the proposed dividend is concerned, it does not fall in the category of a "reserve" and cannot be included in the capital base of the assessee-company for the purpose of Super Profits Tax Act, 1963.
Wednesday, 7th October, 1992.
12. Question No. 2 deals with excess depreciation. Assessee had debited a larger amount of depreciation to the P&L account consequently reducing its profits in the P&L account, and its reserves and surplus in the balance sheet. The assessee adjusted the value of the fixed assets as shown in the balance sheet accordingly. The ITO has, however, allowed a smaller depreciation as per the IT Act. The excess book depreciation can be worked out from the figures in the balance sheet of the assessee and the income-tax records. Accordingly to the assessee, the written down value of its assets was Rs. 3,87,043 whereas their book value as on 1st July, 1992 (i.e., to say first of the previous year) was Rs. 3,34,476. The difference of Rs. 52,567 is claimed by the assessee as being in the nature of a reserve and, hence, includible in the capital base of the company for the purpose of Super Profits Tax Act, 1963.
13. Under s. 205(2) of the Companies Act, a company is entitled to calculate depreciation in one of the several manners described in sub-s. (2). As per sub-s. (2), a company can provide depreciation (a) to the extent specified in s. 350; or (b) in respect of each item of depreciation asset, for such an amount as is arrived at by dividing ninety-five per cent of the original cost thereof to the company of each such depreciable asset on the expiry of the specified period in respect of such assets, or in any other manners laid down in that sub-section. Under s. 350, (as it stood at the relevant time) the amount of depreciation which was required to be deducted for the purpose of tax was at the rate specified for the assets by the Indian IT Act, 1922 and the rules made thereunder for the time being in force. In other words, under the Companies Act, it is open to a company to provide for depreciation either in the manner provided under the IT Act or in some of the other manners prescribed under s. 205(2). The depreciation so prescribed is required to be shown in the balance sheet of the company as set out in Schedule VI of the Companies Act. Part I-A of Schedule VI Shows the balance sheet of the company in the horizontal form. As per this proforma, fixed assets have to be shown at the original cost and the additions thereto, deductions therefrom during the year, and the total depreciation written off or provided upto the end of the year. Note (e) of the Notes at the foot of the proforma relating to general instructions for preparation of a balance sheet, states, "Depreciation written off or provided shall be allocated under the different asset heads and deducted in arriving at the value of fixed asset". Part I-B of Schedule VI sets out the vertical form of the balance sheet it also requires fixed assets to be shown as (a) gross block, (b) less depreciation, (c) net block and (d) capital work-in-progress. This clearly goes to show that the company is required to show in the balance sheet the value of its fixed assets in the manner so prescribed including the quantum of depreciation provided by the company.
14. Part III Schedule VI is headed -
"INTERPRETATION
7.(1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires, -
(a) the expression 'provision' shall, subject to sub-cl. (2) of this clause, mean any amount written off or retained by way of providing for depreciation, ......;
(b) the expression "reserve" shall not, subject as aforesaid, include any amount written off or retained by way of providing for depreciation ...........;
(c) ........................
(2) Where -
(a) any amount written off or retained by way of providing for depreciation .................; or
(b) any amount retained by way of providing for any known liability;
is in excess of the amount, which in the opinion of the directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this Schedule as a reserve and not as a provision."
These provisions clearly show that excess depreciation should be treated as a reserve.
15. In the present case, the assessee has shown the quantum of depreciation as per s. 205(2) of the Companies Act. The assessee, however, has chosen a method of calculating depreciation other than the one prescribed under the IT Act. As a result, the quantum of depreciation which is provided is larger than the quantum of depreciation allowed under the provisions of the IT Act. For the purposes of the IT Act, therefore, there is an excess provision for depreciation. The provisions of Super Profits Tax Act 1963 are linked with the provisions of the IT Act. For the purpose of determining chargeable profits, the total income of the assessee computed under the IT Act, 1961 has to be taken into account and has to be adjusted in accordance with the provisions of the First Schedule. The excess provision for depreciation, therefore, is clearly relevant for the purpose of Schedule II of the Super Profits Tax Act, 1963. As set out by the Supreme Court in the case of Vazir Sultan Tobacco Co. (supra) any excess provision has to be treated as a reserve. This ratio will apply to the present case also. Therefore, excess provision of depreciation should be treated as a reserve.
16. In this connection, we may also refer to another decision of the Supreme Court in the case of CIT vs. Elgin Mills Ltd. . In that case also the Supreme Court has observed that the expressions 'provision' and 'reserve' are defined in Schedule VI, Part III of the Companies Act, 1956. The distinction between 'provision' and 'reserve' must be found out bearing in mind the main features of the two. A provision is a charge against the profits and, therefore, has to be taken into account in the gross receipts of the P&L account in 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 in the P&L account is a provision. There is no dispute on this question. The only dispute is in relation to the excess amount of depreciation so shown and provision so made. For reasons set out earlier excess provision so made is to be treated as a reserve.
17. Our attention was also invited to a decision of the Madras High Courts in the case of United Nilgiri Tea Estates Co. Ltd. vs. CIT reported in (1974) 96 ITR 734 (Mad). In that case the Madras High Court was, inter alia, concerned with a similar case and it held that the amount at the credit of the depreciation reserve account in excess of the amount allowed for tax purposes stands on the same footing as excess provision for development rebate and, hence, it will have to be treated as a reserve for the purposes of the Super Profits Tax Act, 1963. In the subsequent case of CIT vs. English Electric Co. of India Ltd. reported in ((1985) 151 ITR 116 (Mad), the Madras High Court, inter alia held that the depreciation claimed by the assessee in excess of the amount allowable under the IT Act had to be taken as excess provision for depreciation. This was to be taken note of as a reserve in the computation of capital for the purpose of surtax. The Madras High Court relied upon its decision in the case of United Nilgiri Tea Estates Co. Ltd. (supra) and held that excess depreciation has to be taken to be an excess provision for depreciation. It also said that this can be taken as a reserve although such an excess is not an appropriation out of profits; it cannot be taken as a provision. The Court also said that the excess depreciation had been actually shown separately in the balance sheet.
18. In the present case, the depreciation which has been claimed by the assessee is clearly shown in the balance sheet. It is an accepted position that the amount so shown is in excess of what is allowed under the It Act. Therefore, for the purposes of the IT Act and the Super Profit Tax Act, 1963, such excess provision for depreciation has to be treated as a reserve by applying the principles laid down in the case of Vazir Sultan Tobacco Co. Ltd.'s case. In a similar situation, the Calcutta High Court has come to a similar conclusion in the case of CIT vs. Indian Leaf Tobacco Development Co. Ltd. . In that case the assessee-company had, over the years, debited in its books, depreciation which was in excess of the depreciation allowed under the IT Act and claimed the same as a reserve to be included in the computation of capital under the Super Profits Tax Act, 1963. The Calcutta High Court held that there was an excess depreciation which was mentioned as "excess" for depreciation purposes and it was set apart for use in future. Though there was no specific finding or evidence to the effect that the directors had decided to treat the excess depreciation as a reserve, it was built up out of profits earned by the company and was not intended to be distributed as dividend to the shareholders but was kept back by the directors for any purpose to which it might be put in future. The substance of the matter indicated that the amount was not to be expended but had to be kept back for future use. Hence, this was a 'reserve' within the meaning of r. 1 of Schedule II to the Super Profits Tax Act, 1963 and could not be included in the computation of capital for purposes of Super Profits Tax.
19. In the present case also the excess provision for depreciation has been made out of the profits of the company. It is not to be expended but it is to be retained for future use. Hence, such excess provision amounts to a reserve within the meaning of r. 1 of Schedule II of the Super Profits Tax Act, 1963 and can be included in the computation of capital for purposes of Super Profits Tax Act.
20. Dr. Balasubramanian, however, drew our attention to two judgments of this High Court, one being in the case of CIT vs. Zenith Steel Pipes Ltd. reported in (1990) 181 ITR 291 (Bom) and the other being in the case of CIT vs. Indian Dyestuff Industries Ltd. reported in (1991) 191 ITR 168 (Bom). In the former case, the assessee had claimed in its books on account of depreciation which was less than what was allowed under the provisions of the IT Act. The assessee transferred the amount representing the difference between the depreciation claimed in the returns and the depreciation debited in the books, from its general reserves to General Reserve Account No. 1. This amount was, in the subsequent assessment years, capitalised for issue of bonus shares. For the asst. yr. 1967-68 in which year the amount was not so capitalised the Court said that the difference between the depreciation actually allowed to the assessee and the depreciation actually provided in the account should be deducted from the capital base for the relevant assessment year. Similarly, in the latter case of India Dyestuff Industries Ltd. (supra), the assessee had deducted in its books of account less amount of depreciation than the amount of depreciation which was actually allowed. The Court held that this difference was not includible in the capital of the company for purposes of the Companies (Profits) Surtax Act. We fail to understand how these decisions will help Dr. Balasubramanian in this case. On the contrary, the ratio of these judgments supports the assessee. These are converse cases where the difference arose on account of less amount being provided by way of depreciation in the books of account of the company, thereby resulting in an increase in the reserves of the company. Our High Court has held that this extra amount cannot be considered as a reserve. The case before us is the opposite case where the assessee has made an excess provision for depreciation. This is an extra amount which is available to the assessee which it has retained. Hence, this amount will clearly go to argument the reserves of the company for the purpose of calculating the capital base of the assessee for the purpose of Super Profits Tax Act, 1963.
21. In the premises. Question No. 1 is answered in the negative and in favour of the Revenue, save and except that if it is found that there is any excess provision for taxation, the same will constitute a reserve and shall be included in computing the capital base of the assessee for the purposes of Super Profits Tax Act, 1963.
Question No. 2 is answered in the negative and in favour of the assessee.
In the circumstances of the case, there will be no order as to costs.