2007 (4) TMI 225 - HC - Income Tax

Inclusion of Profits in Capital for Surtax + Ruling on Scientific Research Expenditure

The Tribunal held that unappropriated profits shown in the UK accounts should be included in the capital computation for surtax assessment. The High Court ... - Issues Involved:1. Inclusion of unappropriated profits in the capital computation for surtax assessment.2. Inclusion of capital expenditure on scientific research in the capital computation for surtax assessment.Detailed Analysis:Issue 1: Inclusion of Unappropriated Profits in the Capital Computation for Surtax AssessmentThe first issue concerns whether unappropriated profits shown in the profit and loss accounts of the head office of the assessee in the United Kingdom can be excluded from the 'capital' to be computed for the purpose of surtax assessment. The Tribunal held that these unappropriated profits cannot be excluded from the capital computation.The Commissioner had initially found that the capital declared by the assessee, which included unappropriated profits, was erroneous and prejudicial to the interests of the Revenue. Consequently, the Commissioner directed the Assessing Officer to reframe the assessment, excluding such reserves. However, the Tribunal, upon appeal, accepted the assessee's contention that under the UK Companies Act and generally accepted UK accounting practice, retained profits at the end of each year are carried forward as a reserve without needing a formal resolution.The Tribunal noted that the balance-sheet of the company showed 'other reserves' which included unappropriated profits. It concluded that these unappropriated profits automatically form part of the other reserves at the end of the year and should be included in the capital base of the company for surtax purposes. The Tribunal's decision was influenced by the accounting practices in the UK and USA and a letter dated October 7, 1991, which explained the treatment of these profits.The High Court upheld the Tribunal's decision, stating that the Tribunal's findings were based on facts and accounting practices that were neither denied nor doubted by the Department. The Court also referenced the Supreme Court's decision in First National City Bank v. CIT, which supported the inclusion of undivided profits in the reserves for capital computation.Issue 2: Inclusion of Capital Expenditure on Scientific Research in the Capital Computation for Surtax AssessmentThe second issue pertains to whether the capital expenditure on scientific research, as appearing in the United Kingdom accounts of the company, can be considered part of the reserves for surtax assessment. The Tribunal had ruled in favor of the assessee, stating that such expenditure should not be excluded from the capital computation.The Tribunal examined the general entries made by the assessee for such expenses, noting that the deduction allowed in the computation of income was represented by the amount debited to the asset account. The Tribunal found that the second entry, which debited the profit and loss account and credited the general reserve account, was unnecessary for claiming the deduction and was merely for creating a separate reserve.The High Court, however, disagreed with the Tribunal's findings. It held that the Tribunal erred in not considering the second entry in the reserve account, which should be noticed for the purpose of a finding. The Court emphasized that the Explanation to rule 1(iii) of the Second Schedule clearly indicated that such reserves should not be considered for capital computation. Therefore, the Court answered this question in favor of the Revenue.Conclusion:The High Court partially accepted the reference. The first question of law was answered in favor of the assessee, affirming that unappropriated profits in the UK accounts should be included in the capital computation for surtax assessment. The second question of law was answered in favor of the Revenue, ruling that capital expenditure on scientific research should not be included in the capital computation. The judgment was ordered accordingly, with no costs.