Insurance business income must be computed under the special schedule, with only expressly permitted valuation adjustments and deductions.

Income of an insurance business must be computed exclusively under the special statutory schedule, so securities income placed at the branch's disposal could not be taxed under the residuary head as income from other sources. An omitted item of accrued interest could not be added back to the actuarial valuation because only adjustments expressly permitted by the schedule were allowable. The deduction under rule 3(a) applied to the computation of the valuation itself and was not contingent on the existence of a surplus, so it remained available even where the valuation showed a deficit.

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Issues: (i) Whether income earned from securities placed at the disposal of the Bombay branch by the head office of an insurance company could be taxed under the residuary head as income from other sources instead of being computed under the special rules applicable to insurance business; (ii) whether an amount of Rs. 74,511, representing interest accrued before 1 January 1944 but omitted from the actuarial valuation because of a change from receipt basis to accrual basis, could be added back to the valuation surplus; (iii) whether the deduction under rule 3(a) of the Schedule was allowable even though the actuarial valuation disclosed a deficit and not a surplus.

Issue (i): Whether income earned from securities placed at the disposal of the Bombay branch by the head office of an insurance company could be taxed under the residuary head as income from other sources instead of being computed under the special rules applicable to insurance business.

Analysis: Under section 10(7) of the Income-tax Act, 1922, the profits and gains of insurance business, and the tax payable thereon, must be computed in accordance with the Schedule, notwithstanding sections 8, 9, 10, 12 or 18. Income arising from securities held for the insurance business was therefore part of the insurance business profits and could not be brought to tax under section 12. The Schedule alone governed the computation, and no provision in the Schedule authorized the Department to assess the amount as income from other sources.

Conclusion: The issue was answered in favour of the assessee and against the Revenue.

Issue (ii): Whether an amount of Rs. 74,511, representing interest accrued before 1 January 1944 but omitted from the actuarial valuation because of a change from receipt basis to accrual basis, could be added back to the valuation surplus.

Analysis: The actuarial valuation had been correctly made on the basis then adopted, and any later change in the accounting method did not by itself authorize the Department to alter the valuation. Rule 2(b) of the Schedule confined adjustments to the additions and deductions expressly permitted by that rule. Since the proposed correction was not one falling within rule 2(b), the Department had no legal power to increase the surplus by adding the omitted interest.

Conclusion: The issue was answered in favour of the assessee and against the Revenue.

Issue (iii): Whether the deduction under rule 3(a) of the Schedule was allowable even though the actuarial valuation disclosed a deficit and not a surplus.

Analysis: Rule 3(a) allowed four-fifths of the amounts paid to, reserved for, or expended on behalf of policy holders as a deduction in computing the surplus for the purpose of rule 2. The language of the rule did not make its application dependent on the existence of an actual surplus. The deduction applied to the computation itself: if the result was a surplus, it would be reduced, and if the result was a deficit, the deficit would be increased by the permitted deduction.

Conclusion: The issue was answered in favour of the assessee and against the Revenue.

Final Conclusion: The reference was substantially answered in favour of the assessee, with the Department failing on the principal substantive questions of taxability and computation under the insurance schedule.

Ratio Decidendi: The special computation scheme for insurance business is exhaustive and excludes assessment under the general residuary head, while only those adjustments expressly permitted by the Schedule can be made in actuarial valuation, and the deduction under rule 3(a) applies in computing both surplus and deficit.

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