Banking reserve computation after tax and RBI-directed reserves qualify for surtax exclusion under the statutory schedule.

A banking company's reserve under section 17(1) of the Banking Regulation Act is computed on profits after tax, because the statutory profit balance is determined after necessary provisions, including tax. Reserves created in obedience to binding Reserve Bank directions under section 35A are treated as reserves required under section 17(1) and, on that basis, qualify for exclusion under rule 1(xi)(a) of the First Schedule to the Companies (Profits) Surtax Act. The assessee was therefore entitled to exclude those amounts from chargeable profits, and the contrary revenue view was rejected.

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Issues: (i) Whether the reserve required under section 17(1) of the Banking Regulation Act, 1949 is to be computed on profits before tax or after tax. (ii) Whether reserves created in compliance with directions issued by the Reserve Bank of India under section 35A of the Banking Regulation Act, 1949 qualify for exclusion under rule 1(xi)(a) of the First Schedule to the Companies (Profits) Surtax Act, 1964.

Issue (i): Whether the reserve required under section 17(1) of the Banking Regulation Act, 1949 is to be computed on profits before tax or after tax.

Analysis: Section 17(1) requires a banking company to transfer to reserve fund an amount equivalent to not less than twenty per cent of the balance of profit of each year as disclosed in the profit and loss account prepared under section 29. The balance of profit under that statutory scheme was held to mean the profit after taking into account all necessary provisions, including tax provision, because the profit and loss account of a banking company is structured on net income after such deductions and dividend can be considered only thereafter.

Conclusion: The reserve under section 17(1) is to be computed on profits after taxation, and the assessee's construction was rejected.

Issue (ii): Whether reserves created in compliance with directions issued by the Reserve Bank of India under section 35A of the Banking Regulation Act, 1949 qualify for exclusion under rule 1(xi)(a) of the First Schedule to the Companies (Profits) Surtax Act, 1964.

Analysis: The Reserve Bank of India was held to have power under section 35A to issue binding directions requiring banks to maintain reserves at a higher level than the statutory minimum. Amounts set apart in obedience to such directions, even where the bank was later granted relaxation as a special case, were treated as reserves required under section 17(1) read with the binding directions. On that footing, the amounts credited by the assessee were within the class of reserves excluded by rule 1(xi)(a).

Conclusion: The assessee was entitled to exclude the reserves from chargeable profits, and the revenue's view was rejected.

Final Conclusion: The consolidated order enhancing the chargeable profits was set aside and the assessments made by the Income-tax Officer were restored, leaving the assessee entitled to the claimed exclusion.

Ratio Decidendi: A reserve created by a banking company in obedience to binding Reserve Bank directions issued under section 35A of the Banking Regulation Act, 1949 is a reserve required under section 17(1) of that Act and is excludible under rule 1(xi)(a) of the First Schedule to the Companies (Profits) Surtax Act, 1964.

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