Case Law Companies 1953 Petitioner: Commissioner Of Income-Tax Bombay City Vs.Respondent:The Century Spinning And Manufacturing Co.Ltd.The Century

Case Law Companies 1953

Petitioner: Commissioner Of Income-Tax Bombay City Vs.

Respondent:The Century Spinning And Manufacturing Co.Ltd.The Century

 

 

DATE OF JUDGMENT: 08/10/1953

BENCH:

HASAN, GHULAM

BENCH:

HASAN, GHULAM

SASTRI, M. PATANJALI (CJ)

DAS, SUDHI RANJAN

BOSE, VIVIAN

BHAGWATI, NATWARLAL H.

 

CITATION:

 1953 AIR  501 1954 SCR  203

 CITATOR INFO :

 R 1961 SC 812       (5,11)

 RF1966 SC1393    (13,16,23)

 R 1981 SC2105 (8,26,37,40,41,43,46)

 

 

ACT:

Business Profits Tax Act (XXI of 1947), Sch.  II, rr. 2 and  3–Determination of capital  of company-Inclusion  of `reserves’–  Accumulated profit carried over to  next year without  declaring  it as  reserve-Whether  ‘reserve’-IndianCompanies Act (VII of 1913), ss. 131-A, 132, Sch.  I,Table  A, Reg. 99.

 

HEADNOTE:

The  balance sheet of a company for the  calendar  year 1945  showed  a profit of Rs. 90,44,677,  subject  to the provision  for depreciation and taxation, and, after  giving credit to these items 204 the balance of Rs. 5,08,637 was carried to the balance sheet of the next year on the 1st January, 1946, without making or declaring  it  a reserve.  On the 28th February,  1946, the directors marked it for distribution as dividend, on the 3rd April,  a  resolution  was passed  for  distributing  it  as dividend, and a few days, later it was actually distributed as dividend:

Held,  that as the said sum of Rs. 5,08,637 was  never earmarked  or declared as a reserve, but was, on  the  other hand,  earmarked  for distribution as dividend on  the 28th February  and 3rd April and was actually so distributed,  it  Cannot be deemed to be a reserve and added to the  paid-up capital in determining the company’s capital under rr. 2 and 3 of Sch.  II to the Business Profits Tax Act, 1947, for the chargeable  accounting period commencing on the 1st  April, 1946. Held also, that the profits of the company from the 1st January to  1st  April, 1946, cannot  also  be treated  as reserves.

 

JUDGMENT: CIVIL  APPELLATE JURISDICTION -. Civil Appeals Nos. 157 and 158 of 1952.

Appeals from the Judgment and Order dated the 29th dayof  March, 1951, of the High Court of Judicature  at  Bombay (Chagla C.J. and Tendolkar  J.)  in its Original  Civil Jurisdiction in Income-tax Reference No. 27 of 1950. G.N. Joshi for the Commissioner of Income-tax. R.J.  Kolah for the Century Spinning and  Manufacturing Co.Ltd. 1953.  October 8. The Judgment of the Court was delivered by GHULAM HASAN J. These two connected appeals, one by the Commissioner  of  Income-tax, Bombay, and the other  by the Century Spinning & Manufacturing Co. Ltd., arise out of the judgment  and order of the Bombay High Court delivered on  a reference made by the Income-tax Appellate Tribunal, Bombay.

The two questions of law referred by the Tribunal were as follows:-

(1) Whether the amount of Rs. 5,08,637 is a part of  the reserves’  of  the assessee company as on 1st  April,  1946, within the meaning of rule 2(1) of the rules in Schedule  II to the Business Profits, Tax Act, and 205

(2)  Whether the profits of them assessee company  from 1st January to 1st April, 1946, should be included in the said reserves as on 1st April, 1946. The  High Court  answered  the  first question   in the affirmative and the second in the negative.

The accounting year followed by the assessee is the calendar year  and  the chargeable accounting period is the  1st  of April,            1946, to the 31st of December, 1946, in respect  of the  profits ending with 31st December, 1945. The  profits according to the profit and loss account were Rs. 90,44,677 subject to  the provisions for depreciation  and  taxation. After making  provisions  for these, the balance of Rs. 5,08,637 was carried to the balance-sheet. Two contentions were raised on behalf of the assessee before the   Income-tax  Officer,  the first  being  whether the aforesaid sum could be called a “reserve” within the meaning of  rule  2(1) of the Rules in Schedule II to the Business Profits Tax  Act and whether it should be included  in its reserves  while determining the capital on the 1st  April, 1946;  the  second  that the proportionate  profits  of the assessee  for three months, between the 1st  January,  1946, and the 1st April, 1946, should also be included in the said reserves.  The Income-tax Officer rejected the contention holding that “A ‘reserve’ represents profits set apart for some specific or general purpose and therefore profits which have not been so set apart cannot be treated as forming part of reserves for the purpose of inclusion in  the  capital.” This order was confirmed on appeal by  the  Appellate

Assistant Commissioner but was set aside by the  Income-tax Appellate  Tribunal. Thereupon the Tribunal formulated the two questions aforementioned for reference to the High Court under section 66(1) of the Act, read with section 19 of the Business Profits Tax Act of 1947.  As already stated the High Court  decided  the first question in  favour  of  the assessee and the second in favour of the department .Hence the two appeals.

The Business Profits Tax Act (No.  XXI of 1947) came into force on the 11th April, 1947, having taken 28 206 the  place of the Excess Profits Tax Act which was  repealed  on  the 30th March, 1946.  This Act, as is we] I known, was designed to assess large profits made by companies  carrying on  business  during  the boom years of the  war.   It was revived, as  it  were, after a year in the  shape  of the present Act, though in a modified form. Section 4 Which  is the  charging  section, so far as it is  material  for our purposes, permits the levying on the amount of the  “taxable profits”  during any “chargeable accounting period”,  a tax called the “business profits tax” which shall be  equal  to sixteen and  two-thirds per cent of  the  taxable  profits.

“Taxable  profits” means the amount by  which the  profits during a chargeable accounting period exceed the  abatement in  respect  of that period [section  2(17)]. “Abatement”, according  to  section2  (1) means, in  respect  of any chargeable  accounting period ending on or before  the 31st day of March, 1947, a sum which bears to a sum equal to-

“(a)  in the case of a company, not being  a  company Deemed for the purposes of section 9 to be a firm, six percent. of the capital of the company on the first day of  the said period computed in accordance with Schedule II, or        one lakh of  rupees,  whichever  is  greaterthe same proportion  as the said period bears to the period  of one year ”

“Accounting period” according to section 2(2) in relation to  any business  means any period which  is  or  has been determined  as the previous year for that business  for the purposes  of  the  Indian  Income-tax  Act,  1922.    Lastly “chargeable accounting period” is defined in section 2(4) as follows:-

“(a)  any  accounting period falling wholly within the terms beginning on the first day of April, 1946, and  ending on the thirty-first day of March ;

(b) where any accounting period falls partly within and partly   without the said term, such part of that  accounting period as falls within the said term:”. It  appears  that the definition of  abatement contemplates that the normal profit of a company is six per cent, on its capital and where the, profit exceeds 207 that amount, it becomes liable to pay business profits tax. Schedule 11 lays down the rule for computing the capital  of a company for purposes of business profits tax and rule 2(1) of the Schedule which admittedly applies to the present case lays down that “Where the company is one to which rule 3 of Schedule  I  applies, its capital shall be the sum  of the amounts of its paid-up share capital and of its reserves  in so  far as  they have not beenallowed  in  computing the profits of  the  company for the  purposes  of the  Indian Income-tax Act……….”

The  point  that arises for consideration  on  the  first question  is whether the assessee is entitled to  treat the sum of Rs. 5,08,637 as a reserve and to add it to its  paid- up share  capital  for  the  purposes of computing the abatement.   Two essential characteristics must be  present before the assessee can avail himself of the benefit of the rule,  namely, that the amount should not have been  allowed in computing the profits of the company for the purposes  of Income-tax  Act and  that it should be a  reserve  as con- templated  by the rule.That it has not been so allowed  is not denied and therefore the only question is whether it can be treated as a reserve within the meaning of the rule. The balance-sheet  shows that the company made a profit  of Rs. 90,44,677  for the  calendar  year  1945  subject  to the provision of depreciation and taxation. After giving credit for  these items the balance of Rs. 5,08,637 was carried  to the  balance-sheet on 1st January, 1946, in the profit and loss  account. On the 28th February, 1946,  the  directors recommended that the aforesaid sum should be appropriated in the following manner: —

Payment  of a final dividend at the rate of Rs. 18  per share  (making Rs. 28 per share for the whole year) free  of income-tax absorbing…  Rs.  4,92,426-0-0  Balance  to  be carried forward to next year’s account … Rs. 16,211-6-8

This  recommendation was accepted by the shareholders  in their meeting on the 3rd April, 1946, by a resolution passed to  that effect.  The dividend was made payable on the 15th April, 1946, and it is not 208 Denied that it was actually distributed. These being  the facts, the question arises whether the amount in  question can be called a “reserve”.

The term “reserve” is not defined in the Act and we must resort to  the ordinary natural meaning  as  understood  in common parlance.  The dictionary  meaning  of  the word “Reserve” is :-  ”  1(a) To keep for future use or enjoyment; to  store  up for some time or occasion; to refrain from using  or   enjoying at once.

(b)  To keep back or hold over to a later time or place or other further treatment.

6. To   set  apart for some purpose or with some end in view; to keep for some use.

11. To  retain  or  preserve for  certain  purposes.” (Oxford Dictionary, Vol.  VIII, p. 513).

In  Webster’s New International Dictionary, Second  Edition, page 2118, “Reserve” is defined as follows:

“1. To keep in store for future or special use; to keep in reserve; to retain, to keep, as for oneself.

2. To keep back; to retain or hold over to a    future time or place.

3. To preserve.”

What  is the true nature and character of  the  disputed sum,  must be determined with reference to the substance  of the  matter and when this is borne in mind, it follows that on  the 1st of April, 1946, which is the crucial  date, the sum  of Rs. 5,08,637 could not be called a  “reserve”, for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other  hand,  on  the 28th  February,  1946,  the  directors clearly ear-marked it for distribution as dividend and did not choose to make it a reserve.  Nor did the company in its meeting on  the  3rd  April, 1946, decide  that  it  was  a reserve. It  remained on the 1st of April as a  mass  of undistributed profits which were available for distribution and  not  ear-marked as “reserve”.  On the 1st of  January, 1946, the amount was simply brought from 209 the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The reserve may be a general reserve or a specific reserve, but there  must be a clear indication to show whether it  was  a reserve either of the one or the other kind.  The fact that it  constituted a mass of undistributed profits on  the 1st January,  1946, cannot automatically make it a reserve. On the  1st  April,  1946, which is  the  commencement  of the chargeable   accounting period, there   was merely   a recommendation, by the directors that the amount in question should be distributed as dividend.  Far from  showing that the directors had made the amount in question a reserve,  it shows that they had decided to ear-mark it for distribution as  dividend.  By the resolution of the shareholders on the 3rd   April,  1946,  the  amount  was shortly afterwards distributed as dividend.  The High Court appear to have been under  a misapprehension as to the real position,  for they observed  :-“It was open to the directors to distribute the sum of Rs. 5,08,537 as dividends.  They did not choose to do so  and have kept back this amount. Therefore, by  keeping back  this amount they constituted it a reserve.  A  reserve in  the sense in which it is used in rule 2 can  only mean profit earned by a company and not distributed as  dividend to  the shareholders but kept back by the directors for any purpose to which it may be put in future.  Therefore, giving to  the ‘reserves’ its plain natural meaning, it  is  clear that  the  sum of Rs. 5,08,637 was kept in  reserve  by the company and  not distributed as profits  and  subjected  to taxation. Therefore, it satisfied all the requirements  of rule 2.” The directors had no power to distribute the sum as dividend.They could only recommend, as indeed  they did, and  it was up to the shareholders of the company to  accept that  recommendation  in which case alone  the distribution could  take place.  The recommendation was accepted and the dividend  was actually distributed.  It is, therefore, not correct to say that the amount was kept back.  The nature of the amount which was nothing more than  the undistributed profits of  the  company,  remained  unaltered. Thus the profits lying unutilized and not 210 specially  set a part for any purpose on the  crucial  date did not constitute reserves within the meaning of’  Schedule II, rule 2 (1).

Reference was made to sections 131 (a) and 132 of  the Indian Companies Act. Section 131 (a)  enjoins  upon the directors  to  attach to every balance-sheet a report with respect to the state of company’s affairs and the amount  if any  which they recommend to be paid by way of dividend and the  amount,  if  any, which they propose to  carry  to the Reserve Fund, General Reserve or  Reserve  Account. The latter       section refers to the contents of the  balance-sheet which  is  to be drawn up in the Form marked F in  Schedule

III. This  Form  contains a  separate head  of  reserves.

Regulation 99 of the First Schedule, Table  A,  lays  down”that  the directors may, before recommending  any  dividend set aside out of the profits of the company such sum as they think  proper as a reserve or reserves which shall, at the discretion  of the  directors, be  applicable for  meeting contingencies, or for equalising dividends, or for any other purpose to which the profits of the company may be  properly applied. The Regulation suggests that any sum out of the profits of the company which is to be made as a reserve or reserves must be set aside before the directors recommend any dividend.  In this case the directors while recommending dividend took no action to set aside any portion of this sum as  a reserve or reserves.  Indeed they never applied their mind to this aspect of the matter.  The balance-sheet drawn up by the assessee as showing the profits was prepared  in accordance with the provisions of the Indian Companies Act. These provisions also support the conclusion as to what  is the true nature of a reserve shown in a balance-sheet.

We are, of the opinion that the view taken’ by the Bombay High  Court is erroneous and must be set aside. The appeal of the Commissioner of Income-tax is allowed with costs.

As  regards the second question, Mr. Kolah the  learned counsel  for  the company, frankly conceded  that  the            view taken by the High Court on this part of the case is not open to challenge and is correct.  The 211 High  Court held that the profits for three months from the 1st January, 1946, to the 1st April, 1946, were not reserves which  would attract the application of rule 2 of  Schedule

11. With this conclusion we agree.  The assessee’s appeal is, therefore, dismissed with costs.

Appeal No. 157 allowed.

Appeal No. 158 dismissed.

Agent for the Commissioner of Income-tax:  G.H.

Rajadhyaksha.

Agent for the company: I. N. Shroff.

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