1957 (4) TMI 1 - SC - Income Tax

Reserve for Unexpired Risks Not Accruing Liability under Tax Law

The court held that the reserve for unexpired risks, although treated as a liability for income tax purposes, does not qualify as an accruing liability ... Whether amounts shown by an insurance company as reserves, for unexpired risks on pending policies are liable to be deducted under rule 2 of Schedule II to the Excess Profits Tax Act (XV of 1940)? Held that:- A contingent liability in respect of unexpired risk is not an accruing liability ' within rule 2 of Schedule II to the Act. Appeal dismissed. Issues Involved:1. Whether amounts shown by an insurance company as reserves for unexpired risks on pending policies are liable to be deducted under rule 2 of Schedule II to the Excess Profits Tax Act (XV of 1940).Issue-wise Detailed Analysis:1. Nature of the Reserves for Unexpired Risks:The respondent, an insurance company, set aside a proportion of premiums received as reserves for unexpired risks, typically 40%, treating this as a liability. The appellant contended that this reserve should be deducted as a liability under rule 2 of Schedule II to the Excess Profits Tax Act. The respondent argued that these reserves represent contingent liabilities, not within the scope of rule 2.2. Relevant Statutory Provisions:The Excess Profits Tax Act charges tax on the amount by which profits exceed the standard profits. Standard profits are calculated by applying the statutory percentage to the average amount of capital employed in the business during the chargeable accounting period. Rule 1(c) of Schedule II includes the value of all assets as capital. Rule 2(1) mandates the deduction of borrowed money and debts from the value of the assets, including sums in respect of accruing liabilities allowable as deductions in computing profits for excess profits tax purposes.3. Interpretation of 'Accruing Liabilities':For a sum to be deducted under rule 2, it must be allowable as a deduction in computing profits and must be in respect of accruing liabilities. The respondent's statements to the Controller of Insurance disclosed 40% of premiums as reserves for unexpired risks, treated as liabilities in profit and loss statements, and allowed in income tax assessments. The controversy centered on whether this reserve qualifies as a sum in respect of an accruing liability.4. Judicial Precedents:The appellant cited *Sun Insurance Office v. Clark*, where the House of Lords held that reserves for unexpired risks should be deducted, treating the premium as not wholly earned if the policy period had not fully run. The respondent argued that under Indian law, a contract of insurance is a contingent contract, and unexpired risks cannot be treated as present liabilities. They also pointed to the history of rule 2's enactment, suggesting that accruing liabilities must bear the character of debts.5. Contingent vs. Present Liability:The decision in *Sun Insurance Office v. Clark* indicated that the obligation under unexpired risks is a present liability for tax purposes. However, the Excess Profits Tax Act's scheme differs from the Income-tax Act, focusing on taxing profits above a standard level, influenced by the capital employed. Rule 1 of Schedule II includes all assets used in the business as capital, while rule 2 excludes borrowed money and debts to limit relief to capital contributed by the assessee.6. Application to the Present Case:The reserve for unexpired risks, while considered a present liability for income tax, does not qualify as an accruing liability under rule 2 of Schedule II for excess profits tax. It does not contribute to the business's effective trading assets during the chargeable accounting period. The decision in *Northern Aluminium Co. Ltd. v. Inland Revenue Commissioners* supported this view, holding that a conditional liability under a contract is not an accruing liability for excess profits tax purposes.Conclusion:The reserve for unexpired risks cannot be deducted as an accruing liability under rule 2 of Schedule II to the Excess Profits Tax Act. The appeal was dismissed, affirming the High Court's decision.