Bombay High Court
Commissioner Of Income-Tax vs Indian Reinsurance Corporation Ltd. on 15 September, 1998
Equivalent citations: [1999]236ITR968(BOM)
Author: A.Y. Sakhare
Bench: A.Y. Sakhare
JUDGMENT A.Y. Sakhare, J.
1. By this reference under Section 256(1) of the Income-tax Act, 1961 (for short "the Act"), read with Section 18 of the Companies (Profits) Surtax Act, 1964 (for short "the Surtax Act"), the Income-tax Appellate Tribunal, has referred the following two questions of law to this court for opinion one at the instance of the assessee and the other at the instance of the Revenue.
"(1) Whether, on the facts and in the circumstances of the case, the Tribunal was right in law in holding that the 'premium reserve deposit' account should be treated as a 'fund' within the meaning of Rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and in consequently directing the Surtax Officer to recompute the capital for the purpose of surtax assessment ?
(2) Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that the premium reserve deposit account could not be considered to be moneys borrowed within the meaning of Rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 ?"
So far as question No. 2 is concerned, the assessee had not applied for making reference of the said question. Only during the hearing of the application made at the instance of the Revenue, the assessee made a request for reference of question No. 2. As the Tribunal felt that question No. 2 also required to be referred to this court for its opinion, it has referred this question also to this court. Our attention has been drawn by learned counsel for the Revenue to the Supreme Court decision in the case of CIT v. V. Damodaran [1980] 121 ITR 572, wherein it has been held that the non-applicant has no right to ask for a reference of a question of law on the application made by the applicant. In view of the above decision, the second question is returned unanswered as wrongly referred to this court.
2. We now turn to question No. 1. The material facts necessary for deciding the same are briefly stated as follows. The assessee is a public limited company registered under the Companies Act, 1956. The assessment years under consideration are 1972-73 and 1973-74. In response to the notice under Section 6(1) of the Surtax Act, on September 29, 1972, the assessee filed a return of surtax for the assessment year 1972-73. On October 1, 1973, a return of surtax was filed for the assessment year 1973-74.
3. The assessee is in the business of re-insurance. The assessee enters into treaties with various re-insurers for the purpose of re-insuring the risks undertaken by it. In order to cover the risks of re-insurance, the assessee re-insures the very risk in its own returns with other re-insurers one of them being "Balosie Marine Insurance Company Ltd." of Basle, (hereinafter referred to as "the foreign re-insurer"). The foreign re-insurer agreed to bear the proportionate cost of any excess loss or other re-insurance which the assessee may effect for common account of itself and the foreign re-insurer in respect of any part or the whole of the business which was the subject-matter of the agreement. The assessee was at liberty to effect excess loss re-insurance cover in respect of its own net liability, The premium paid/credited by the assessee to the account of the foreign re-insurer was on the basis of pro rata share of the gross premia on the business received by the assessee. The assessee debited the account of the foreign re-insurer with the corresponding share of all claims, commissions, taxes, brokerages, etc., as charged to the assessee. As per the agreement, the foreign re-insurer was to reimburse the assessee with management expenses on the gross premium coming to its credit. The agreement provided for mode and manner of payment by the foreign re-insurer to the assessee. The agreement further provided the manner in which the accounts were to be maintained. Article VII of the agreement between the assessee and the foreign re-insurer reads as under :
Article VII:
"The Corporation shall be entitled to retain a deposit at the rate specified in the Schedule of the net premiums (premiums less commission) shown in each quarterly account. The deposit so computed shall be set up separately for each underwriting year and the corporation shall credit the retrocessionarie with interest at the rate specified in the Schedule on the deposit so retained. At the end of the first year following each underwriting year the deposit shall be adjusted to the amount of the reserve for outstanding liabilities. If there is any balance of the deposit left after such provision the same shall be refunded to the retrocessionarie. On the other hand, if the deposit is insufficient to meet the amount required for outstanding liabilities, the corporation shall be entitled to make up the deficit from any balance due to the retrocessionarie or shall, alternatively, be entitled to ask the retrocessionarie to make up the deficit, which the retrocessionarie shall do forthwith on demand. The amount thereafter retained as a reserve for outstanding liabilities shall be adjusted annually until all such liabilities are liquidated. If and so far as it may be necessary to secure the corporation in the event of the liquidation either voluntary or compulsory of the retrocessionarie, the corporation shall have a prior charge and lien on the said deposit and also upon any further monies with which the retrocessionarie may be entitled to be credited under the agreement and the Corporation shall be secured creditors to that extent."
The assessee thus retained a part of the premia payable to the foreign re-insurer as a deposit with itself and was to pay interest thereon to the foreign re-insurer from year to year. In other words, the foreign re-insurer allowed the assessee to retain the premia payable by it to ensure proper performance of the contract between them.
4. The Income-tax Officer issued notice under Section 6(1) of the Surtax Act calling upon the assessee to file a return of surtax for the assessment year 1972-73 which was filed by the assessee on September 27, 1972, and the second return was filed on October 1, 1973, for the assessment year 1973-74. Before the Income-tax Officer, the assessee claimed that the amount credited to the premium reserve account forms part of the reserve for the purpose of the capital computation. The Income-tax Officer held that the premium account is an account maintained only towards contingent liability and cannot form part of the reserve for the purpose of capital computation as the assessee had a lien on the premium reserve and in the event of the re-insurer not fulfilling its obligation the assessee had a right to utilise this amount in the reserve. As per the Income-tax Officer, this reserve was only towards contingent liability and cannot form part of the reserve for the purpose of capital computation.
5. The assessee filed two appeals before the Appellate Assistant Commissioner. By orders dated June 28, 1977 and July 27, 1977, these appeals were partly allowed. The Appellate Assistant Commissioner came to the conclusion that the assessee was not entitled to include the amount lying or held as premium reserve deposit in the capital employed in terms of Rule 2(i) of the Second Schedule to the Surtax Act. The Appellate Assistant Commissioner came to the conclusion that no money has passed from the foreign re-insurer to the assessee. Under the agreement, the assessee only deferred the payment of part of the premium due to the foreign reinsurer. There was no positive act of lending and/or borrowing. As per the Appellate Assistant Commissioner, the agreement between the parties only provided for retention of a part of the premium and adjustment thereof on the completion of the contract. Thus, the claim of the assessee to treat the premium reserve account as capital employed in terms of Rule 2(i) of the Second Schedule of the Surtax Act was overruled.
6. The assessee filed two appeals before the Tribunal. By an order dated November 3, 1978, the assessee's alternate submission was accepted and it was held that the premium reserve deposit account should be treated as fund within the meaning of Rule 2(ii) of the Second Schedule of the Surtax Act.
7. The question which calls for determination is whether the premium reserve deposit account maintained by the assessee of the foreign reinsurer is a fund as contemplated under Rule 2(ii) of the Second Schedule of the Surtax Act. The relevant rule reads as under :
"2. Where a company owns any assets the income from which in accordance with Clause (iii) or Clause (vi) or Clause (viii) or rule 1 of the First Schedule is required to be excluded from its total income in computing its chargeable profits, the amount of its capital as computed under rule 1 of this Schedule shall be diminished by the cost to it of the said assets as on the first day of the previous year relevant to the assessment year in so far as such cost exceeds the aggregate of-
(i) any moneys borrowed .... and remaining outstanding as on the first day of the said previous year ; and
(ii) the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under rule 1.
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.
Explanation 2.--Any premium received in cash by the company on the issue of its shares standing to the credit of the share premium account shall be regarded as forming part of its paid-up share capital.
Explanation 3.--Where a company has different previous years in respect of its income, profits and gains, the computation of capital under rules 1, 2 and 3 shall be made with reference to the previous year which commenced first."
As per the agreement between the assessee and the foreign re-insurer, the assessee was entitled to retain a part of the premium payable to the foreign re-insurer as deposit with itself for proper performance of the agreement and was to pay interest thereon. At the end of the year, the deposit was to be adjusted to the amount of the reserve for outstanding liabilities and after the adjustment if there is balance of the deposit the same was to be paid over to the foreign re-insurer. The foreign re-insurer allowed the assessee to retain the premium payable to it as a deposit to ensure proper performance of the contract between the parties. The Income-tax Officer while overruling the assessee's claim held that this reserve was only towards the contingent liability and cannot form part of the reserve for the purposes of capital computation. He also held that the premium payable by the assessee to the foreign re-insurer was retained only for a period of 12 months then released to the foreign re-insurer with interest, therefore, the assessee had a lien on the premium reserve and in the event of the foreign insurer not fulfilling its obligation, the assessee had a right to adjust the said amount. The Appellate Assistant Commissioner overruled the assessee's submissions by holding that as per the agreement between the parties 40 per cent. of the premium was retained by the assessee as a security deposit, the premium reserve deposit was part of the premium payable to the foreign re-insurer, payment of which was deferred till the treaty comes to an end and the said sum does not constitute a loan as envisaged as there was no act of borrowing and lending involved. The Tribunal confirmed the aforesaid findings of the Appellate Assistant Commissioner by holding that the premium reserve deposit does not constitute "monies borrowed" within the meaning of Rule 2(i) of the Surtax Act. However, the Tribunal accepted the assessee's alternate submission that the premium reserve deposit is a fund as envisaged under the Rule 2(ii) of the Surtax Act.
8. We have heard Mr. R. V. Desai, learned counsel for the Revenue. The assessee was unrepresented. Mr. Desai submitted that in view of the decision of the Supreme Court in the cases of K. M. S. Lakshmanier and Sons v. CIT/CEPT [1953] 23 ITR 202 and of CIT v. V. Damodaran [1980] 121 ITR 572, there was no relationship of a lender and debtor between the assessee and the foreign re-insurer. There is a well known distinction between a deposit and a loan and in the present case in the absence of relationship of a lender and debtor between the parties, the assessee's claim that the premium deposit account should be treated as a fund within the meaning of Rule 2{ii) of the Surtax Act cannot be accepted.
9. Rule 2(ii) of the Second Schedule to the Surtax Act provides that where a company owns any assets the income from which in accordance with Clause (iii), (vi) or (viii) of rule 1 of the First Schedule is required to be excluded from its total income in computing its chargeable profits, the amount of its capital as computed under rule 1 of the Second Schedule shall be diminished by the cost to it of the said assets as on the first day of the previous year relevant to the assessment year in so far as such cost exceeds the aggregate of the amount of any fund or any surplus or any such reserve. As per rule 1 of the First Schedule to the Surtax Act profits and gains of any business of life insurance income chargeable under the heads of interest on securities and income received by way of dividend from an Indian company is required to be excluded while computing the assets of the company. As per Rule 2 of the Second Schedule to the Surtax Act, where the company owns any asset the income of which is required to be excluded as per Clause (iii), (vi) or (viii) of rule 1 of the First Schedule to the Surtax Act, the amount of its capital as computed under rule 1 of the Second Schedule to the Surtax Act get diminished in so far as such cost exceeds the aggregate of the amount of any fund or surplus or reserve. Thus, the claim of the assessee that the amount lying at the premium reserve deposit account is a fund, within the meaning of Rule 2(ii) of the Second Schedule to the Surtax Act will have to be examined keeping in mind the provisions of rule 1 of the First Schedule to the Surtax Act. To include the deposit money in the premium reserve deposit account the said amount must be owned by the assessee. Unless and until the amount is owned by the assessee the said amount cannot be treated as a fund for the purpose of Rule 2(ii) of the Second Schedule of the Surtax Act. In the present case, the agreement in substance shows that for the performance of the agreement by the foreign reinsurer 40 per cent. of the premium amount was retained by the assessee-company. At the end of the year or after the termination of the treaty and after adjusting the amount lying at the premium reserve deposit account, balance amount was to be paid over to the foreign reinsurer with interest. The assessee only deferred the payment of the premium payable to the foreign reinsurer for reinsuring the risk. If the said deposit cannot be termed as money borrowed under Rule 2(i) of the Second Schedule to the Surtax Act, then on similar analogy it will be difficult to uphold the Tribunal's reasoning that this is a fund as envisaged under Rule 2(ii) of the Second Schedule to the Surtax Act. It is not necessary to deal with the decisions of the Supreme Court referred to above as both the decisions do not support the claim of the Revenue to interpret the provisions of rules 1 and 2 of the Surtax Act. There is a well known distinction between a deposit and a loan. A deposit means money paid to a person callable as per the agreement between the parties. There is no overt act of lending or borrowing. A loan contemplates act of lending and/or borrowing. In the present case, there is no lending by the foreign re-insurer nor is there borrowing by the assessee. Similarly, the amount kept in the premium reserve account is not a deposit of the foreign reinsurer with the assessee. The assessee has retained some part of the premium payable to the foreign re-insurer for performance of its liability/ responsibility under the treaty. Under the treaty, the assessee had agreed to pay the premium amount retained by it with interest to the foreign reinsurer. In short, under the treaty the parties agreed to defer the premium payable by the assessee to the foreign re-insurer to ensure the performance of the obligation of the foreign re-insurer.
10. Before the Tribunal the assessee has placed reliance upon the decision of this court in the case of CIT v. Bharat Bijlee Ltd. [1977] 107 ITR 30 and the decision of the Calcutta High Court in the case of Duncan Brothers and Co. Ltd. v. CIT[1978] 111 ITR 885. The decision of this court (supra) is not applicable to the facts of the present case. In the case before this court in the year ending on June 30, 1964, a sum of Rs. 1,55,000 was in the dividend account of the assessee-company. Out of the profits of the current year ending on June 30, 1964, the directors appropriated a sum of Rs. 4,35,000 to this account. Thus, the aggregate amount came to Rs. 5,90,000. The company resolved to distribute an aggregate amount of Rs. 2,30,000 as dividend for that year to be paid out of the dividend reserve. The assessee in that case claimed that the entire sum of Rs. 5,90,000 should be added to the capital as dividend reserve. This court held that the dividend reserve can be includible in the computation of capital for the purpose of surtax. However, the quantum of the amount which should be treated as reserve includible in the computation of the capital will depend on the facts of the case. Thus on facts the law laid down by this court is not applicable to the present reference. The Calcutta High Court in Duncan Brothers and Co. Ltd. v. CIT[1978] 111 ITR 885 was considering the case of computation of the capital of the company and whether for the purpose of the Act the same should be treated as a reserve or fund. The Calcutta High Court on facts held that the provisions for taxation constitute a fund within the meaning of Rule 2(ii) of the Second Schedule to the Surtax Act. Thus the decision of the Calcutta High Court is of no assistance to the assessee.
11. The expression "fund" used in Rule 2(ii) of the Second Schedule to the Surtax Act has to be construed in the context of the provisions. The term fund could be an expression of accountancy and/or also could mean actual cash reserve. For finding out the character of the fund the first test will be whether the assessee owns the said amount. In the present case, the premium reserve account cannot be termed as a fund for the purpose of Rule 2(ii) of the Second Schedule to the Surtax Act. The amount lying in the premium reserve deposit account was built as per agreement between the assessee and the foreign re-insurer, the assessee deferred the premium payable by it to the foreign reinsurer and was payable at the end of the year or treaty with interest. In our judgment, the Tribunal was not right in holding that the premium reserve deposit account is a fund within the meaning of Rule 2(ii) of the Second Schedule to the Surtax Act. The moneys lying in the premium reserve deposit account are not monies owned by the assessee nor are the same kept with the assessee as a deposit or loan but the same are part of the premium payable by the assessee to the foreign reinsurer, payment of which was deferred. In our judgment, the Tribunal thus committed error in holding that the premium reserve account should be treated as a fund within the meaning of Rule 2(ii) of the Second Schedule to the Surtax Act.
12. In the result, we answer question No. 1 in the negative, i.e., against the assessee and in favour of the Revenue.
13. Reference disposed of accordingly with no order as to costs.