1980 (5) TMI 14 - HC - Income Tax

Court includes reserves in capital computation for assessment years; reserves vs. provisions distinction clarified.

The court held that the reserve for depreciation on investments and the reserve for doubtful debts should be included in the capital computation for the ... Company, Surtax Issues Involved:1. Inclusion of reserve for depreciation on investments in the capital computation.2. Inclusion of reserve for doubtful debts in the capital computation.Detailed Analysis:Issue 1: Inclusion of Reserve for Depreciation on Investments in the Capital ComputationThe assessee, a limited company, claimed that reserves for depreciation on investments amounting to Rs. 3 lakhs should be included in the capital computation for the assessment years 1964-65, 1965-66, and 1966-67. The Income Tax Officer (ITO) rejected this claim, considering the reserve for depreciation as a provision rather than a reserve. The Appellate Assistant Commissioner (AAC) observed that the word 'reserve' implies 'something specifically kept apart for future use or for specific action' and should be considered a reserve even if created to preserve the company's position against future losses due to depreciation in investment value. The AAC further noted that on the relevant dates, the market value of the investments exceeded their book value, indicating no need for depreciation provision. This strengthened the appellant's case for including the reserve in the capital computation.The Tribunal agreed with the AAC and dismissed the appeal, leading to the reference under section 256(1) of the I.T. Act, 1961. The question referred was whether the reserve for depreciation on investments was a reserve within the meaning of rule I of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and thus includible in the capital computation.The court examined various precedents, including CIT v. Jupiter General Insurance Co. [1975] 101 ITR 370, where the Bombay High Court held that a reserve for doubtful debts, if not earmarked for a specific liability, should be considered a reserve. Similarly, in Parke Davis (India) Ltd. v. CIT [1981] 130 ITR 813, the Bombay High Court held that amounts set apart for bad and doubtful debts on an ad hoc basis without relation to specific liabilities should be treated as reserves.The court also referred to Braithwaite & Co. (India) Ltd. v. CIT [1978] 111 ITR 729, where it was held that provisions for existing liabilities could not be considered reserves. The distinction between 'reserve' and 'provision' was emphasized, with 'reserve' being profits set apart for future use, while 'provision' was for meeting existing liabilities.In conclusion, the court held that the reserve for depreciation on investments should be considered a reserve for capital computation purposes, as it was not for any specific liability and was set apart for future contingencies.Issue 2: Inclusion of Reserve for Doubtful Debts in the Capital ComputationFor the assessment years 1965-66 and 1966-67, the assessee claimed that reserves for doubtful debts should be included in the capital computation. The ITO rejected this claim, but the AAC accepted it, noting that the reserve for doubtful debts was created on an ad hoc basis and exceeded the actual provision for doubtful debts. The AAC directed the inclusion of these reserves in the capital base.The Tribunal upheld the AAC's decision, leading to the reference under section 256(1) of the I.T. Act. The question was whether the reserve for doubtful debts was a reserve within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and thus includible in the capital computation.The court referred to several precedents, including CIT v. Jupiter General Insurance Co. and Parke Davis (India) Ltd. v. CIT, where reserves for doubtful debts created on an ad hoc basis were considered reserves. The court also considered the principles laid down in CIT v. Century Spinning and Manufacturing Co. Ltd. [1953] 24 ITR 499 (SC), where a reserve was defined as profits set apart for future use.In conclusion, the court held that the reserve for doubtful debts should be considered a reserve for capital computation purposes, as it was not for any specific liability and was set apart for future contingencies.Judgment:Both issues were answered in the affirmative and in favor of the assessee. The reserve for depreciation on investments and the reserve for doubtful debts were held to be reserves within the meaning of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and thus includible in the capital computation for the relevant assessment years. There was no order as to costs.