Depreciation Fund not Reserve under Indian Income-tax Act

The Court held that the "Buildings and Machinery Depreciation Fund" did not constitute a reserve within the meaning of the first proviso to section 23A(1) of the Indian Income-tax Act. The Court found that the fund did not represent accumulations of past profits but rather reflected depreciation deductions necessary to ascertain the true profits of the company. As a result, the Court answered the question in the negative and directed the Commissioner to pay the assessee company's costs of the reference.

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Issues Involved:
1. Whether the Buildings and Machinery Depreciation Fund constitutes a reserve within the meaning of the first proviso to section 23A(1) of the Indian Income-tax Act, 1922.

Issue-wise Detailed Analysis:

1. Whether the Buildings and Machinery Depreciation Fund constitutes a reserve within the meaning of the first proviso to section 23A(1) of the Indian Income-tax Act, 1922:

This reference was made under section 66(1) of the Indian Income-tax Act, 1922, at the instance of the Commissioner of Income-tax, Bombay North, Ahmedabad. The assessee in this case is the Viramgam Mills Co. Ltd. The relevant assessment year is 1952-53, the accounting year being the calendar year 1951. The assessee company is one in which at the relevant time the public were not substantially interested as envisaged under section 23A of the Income-tax Act.

The balance-sheet of the company for the accounting year showed the paid-up capital of the company as Rs. 6,98,000. On the liabilities side of the balance-sheet, there were the "Buildings and Machinery Depreciation Fund" amounting to Rs. 6,24,948, the "Reserve Fund" amounting to Rs. 2,20,000, and the "Income-tax Fund in excess of requirement" amounting to Rs. 93,387, making in all Rs. 9,38,335. The sum of Rs. 6,24,948 under the heading "Buildings and Machinery Depreciation Fund" had been carried forward from year to year in the balance-sheets of the company from the year 1946 onwards.

In 1946, the assessee company had sold its buildings and machinery and realized a sum of Rs. 4,00,000 for its buildings and Rs. 21,99,038 for its machinery, thus realizing in all a sum of Rs. 25,99,038. The original cost of these buildings was Rs. 3,15,264, and that of the machinery was Rs. 10,44,491, making in all Rs. 13,59,755. The sum of Rs. 6,24,948 was made up of various amounts shown in the Buildings and Machinery Depreciation Fund year after year up to and including the calendar year 1945. In the balance-sheet as on December 31, 1945, the original cost of Rs. 13,59,755 was shown on the "Assets side" and the provision of Rs. 6,24,948 was shown on the liabilities side under the head "Buildings and Machinery Depreciation Fund".

For the assessment year 1952-53, the company's return showed an income of Rs. 81,860. It was assessed on an income of Rs. 81,935 and the tax thereon amounted to Rs. 35,591, leaving a balance of Rs. 46,344. The assessee company at its general meeting held on December 5, 1952, declared a dividend of Rs. 27,920, i.e., a little over 60 percent of Rs. 46,344. The Income-tax Officer, having regard to the paid-up capital of the company and the total of the balances in the aforesaid three accounts amounting to Rs. 9,38,335, considered that the first proviso to section 23A of the Income-tax Act was applicable to the case. He considered the balance in the three accounts as reserves representing the accumulation of past profits. He directed that the balance of Rs. 18,424 (Rs. 46,344 minus Rs. 27,920) also should be deemed to have been distributed among the shareholders of the company as on December 5, 1952.

The Appellate Assistant Commissioner confirmed the action of the Income-tax Officer. There was a further appeal to the Income-tax Appellate Tribunal. It held that the sum of Rs. 2,20,000 shown as a "Reserve Fund" and the sum of Rs. 93,387 shown under the heading "Income-tax Fund in excess of requirement" constituted reserves as contemplated under the aforesaid proviso. As regards the sum of Rs. 6,24,948 under the heading "Buildings and Machinery Depreciation Fund," the Income-tax Tribunal held that the same did not represent accumulations of past profits and that the same could not have been the subject-matter of an order under section 23A in the past. The Tribunal held that the Income-tax Officer was not justified in passing an order under the proviso to section 23A(1). A question of law having arisen, a statement of the case has been prepared and the matter has been referred to the Court under section 66(1).

The question of law that arose was: "Whether, on the facts and circumstances of the case, the Depreciation Fund constitutes a reserve within the meaning of the first proviso to section 23A(1)Rs."

The learned Advocate-General argued that the Buildings and Machinery Depreciation Fund constitutes a reserve within the meaning of the first proviso to section 23A as it stood at the relevant time. The proviso requires that the reserves shown in the balance-sheet must represent accumulations of past profits and that the past profits must have been such as could have been the subject of an order under sub-section (1) of section 23A.

The learned Advocate-General contended that the sum of Rs. 6,24,948 represented accumulations of past profits, urging that various amounts had been set apart under the head "Buildings and Machinery Depreciation Fund" year after year and that the same must be regarded as having come out of past profits. He referred to a passage from Palmer's Company Law and rules for ascertaining "divisible profits." He also referred to the significance of depreciation reserves as discussed in Paton's Accountants' Handbook and Wixon's Accounts Handbook, which state that depreciation reserves represent the estimated expiration of asset value and do not constitute a fund of cash or other assets set aside to make good the depreciation.

The Court observed that the sum of Rs. 6,24,948 in the present case does not represent a specific fund or cash or other assets set aside to make good the depreciation. The buildings and machinery of the company throughout the years during which the sum of Rs. 6,24,948 has been built up have been shown at cost. The company could have shown them at a written down value after deducting the amount of depreciation which those assets had undergone. The sum of Rs. 6,24,948 represents the estimated expiration of asset value and does not represent accumulations of past profits. The profits of the assessee company for the relevant years could only be truly ascertained after providing for the depreciation in the aforesaid assets of the company. An allowance for depreciation has to be made before the true profits are ascertained. The amount of depreciation does not represent something set apart out of the profits after the same are ascertained.

In the present case, the "Buildings and Machinery Depreciation Fund" account represents the amounts deducted year after year by way of depreciation in order to arrive at the true profits of the company. There is no evidence to show that the sum of Rs. 6,24,948 or any part thereof was built up out of any profits. It is not shown that any provision made by way of depreciation was in excess of the true requirement.

The Court referred to the decision of the Supreme Court in Commissioner of Income-tax v. Bipinchandra Maganlal & Co., which observed that the difference between the written down value of an asset and the price realized by the sale thereof was not really income but was made taxable income for the purpose of computation of the assessable income by the fiction in the second proviso to section 10(2)(vii) of the Income-tax Act. This judgment does not touch the question to be decided in the present case.

In conclusion, the Court held that the reserves in this case do not represent accumulations of past profits. The answer to the question was in the negative, and the Commissioner was directed to pay the assessee company's costs of the reference.

Question answered in the negative.

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