TaxTMI 
TaxTMI 
1981 (5) TMI 16
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.... the statutory deduction under the Act : As on 1-4-1965 As on 1-4-1966 Rs. Rs. 1. Staff benefit reserve 67,854 1,25,732 2. Self-insurance reserve 7,08,696 14,98,878 3. Staff bonus reserve nil 13,31,893 The ITO was of the opinion that the above three items were in the nature of " current liabilities and provisions " and could not, therefore, be treated as " reserves ". The AAC agreed with this view., But, on further appeal, the Tribunal held that the amounts were " reserves ". At the instance of the Commissioner, the following questions have been referred to us for our decision: For the assessment year 1966-67: " Whether, on the facts and in, the circumstances of the case, the Tribunal was correct in law in holding that the accounts styled as 'staff benefit reserves' and 'self-insurance reserve' were outside the scope of the Explanation to rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, and the amounts standing to the credit thereof constitute reserves within the meaning of the said Schedule? For the assessment year 1967-68 : Whether, on the facts and in the circumstances of the case, the Tribunal was correct in law in holding that ....
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....e lines as the 1963 Act and defined the capital of the company as the aggregate of the amounts of its paid-up share capital and its reserves in the same language as the 1963 Act. However, an Explanation was added in the following terms: " Explanation.-For the removal of doubts it is hereby declared that any amount standing to the credit of any account in the books of a company as on the first day of the previous year relevant to the assessment year which is of the nature of item (5) or item (6) or item (7) under the heading 'RESERVES AND SURPLUS' or of any item under the heading 'CURRENT LIABILITIES AND PROVISIONS' in the column relating to 'Liabilities' in the 'Form of Balance-sheet given in Part I of Schedule VI to the Companies Act, 1956 (1 of 1956), shall not be regarded as a reserve for the purposes of computation of the capital of a company under the provisions of this Schedule." Neither the 1963 Act nor the Act presently under consideration contained a definition of the term " reserve ". But the 1964 Act clarifies by means of a reference to the form of balance-sheet prescribed for companies under the Companies Act that an item which is displayed in the balance-sheet un....
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.... the profit and loss account; and the expression 'revenue reserve' shall mean any reserve other than capital reserve." A sub-paragraph appended to sub-cl. (1) clarifies that the expression "liability " used in the sub-clause shall include all liabilities in respect of expenditure contracted for and all disputed or contingent liabilities. Subclause (2) of the above rule clarifies that where an amount of provision is made in excess of the amount which in the opinion of the directors is reasonably necessary for the purpose the excess shall be treated for the purpose of the Schedule as a " reserve " and not as a " provision ". It is in the context of the above provisions of the 1964 Act that the questions in the present case have to be decided and it will be convenient at the present stage to briefly set out the nature of the three items of appropriations made by the assessee. The first item is the staff benefit reserve. The management of the Corporation was setting apart a portion of the surplus every year under different heads and " staff benefit reserve " was one of the heads under which such allocation was made year after year. This amount was kept aside for the implementa....
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....tribution of the maximum bonus for any year could be set on and added to the surpluses available in a subsequent year to declare a higher bonus. Such carry forward for set off or set on was envisaged for a period of four accounting years. The practical application of this principle which has been modified in certain aspects by an amendment of 1976, with effect from September 25, 1975, with which we are not concerned, has been illustrated in the Fourth Schedule (now the Third Schedule)-to the Act. The company, therefore, set aside out of its profits certain sums representing the " set on " that would be necessary to meet a possible deficiency of profits in a future year when it may be required to distribute the minimum bonus despite the absence of sufficient profits. The last item in dispute is the " self-insurance reserve ". The Corporation was operating a scheme of self-insurance to economise on insurance charges. The Corporation was importing various commodities from abroad and it had to insure the same against loss in marine transit. comprehensive insurance of all the commodities for their full value with insurance companies against all risks was considered to be uneconomical....
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....ny in this respect in the year under consideration and that unless and until some deficiency of profits arose in a subsequent year there would be no liability on the part of the Corporation to distribute a bonus and so this amount was also reserve and could not be treated as a provision. So far as the third item was concerned, the Tribunal was of the opinion that despite the fact that there was a scheme formulated, the accumulations in the account did not partake of the nature of liabilities as there was no known liability against the Corporation for the amounts in question and, therefore, they could not be treated as liabilities but could be treated only as reserves. We think that there can be no doubt at all that the conclusion of the Tribunal was clearly right in so far as the amounts set apart for the " staff benefit reserve " and " self-insurance reserve " were concerned. Though the form of balance-sheet prescribed under the Companies Act refers to provisions for insurance and staff benefit schemes for inclusion under item 12 under the sub-head " Current Liabilities and Provisions ", the question whether any particular item has to be listed under the " Current Liabilities a....
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....r of the staff or his family, the relief is provided for only in cases where it is not admissible under the normal rules. There is no claim on the part of the staff by which it could insist that the monies should be given in any particular case. So also the grant in aid for sports and recreation clubs is a matter of disbursement at the will and pleasure of the corporation. In other words, though the company has built up fund for the benefit of various employees of the company and though the company has also formulated for its own guidance various schemes and rules according to which amounts would be given out of this fund, there is no corresponding right on the part of any employee to claim as of right any funds out of this appropriation. Per contra there is no liability whether present or future on the part of the company to spend the money in any particular way for the benefit of any particular employee. The fund set apart in this account cannot, therefore, be described as a fund to meet any known liability present or even future. They are clearly funds accumulated by the company from time to time out of its profits with a view to be spent for such advantage of the employees as t....
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....tingency of its being compelled to distribute a bonus despite the loss of profits in that year, the amounts credited to this account can be described as amounts set apart to meet a future contingent liability the exact amount of which cannot be ascertained with substantial accuracy at the date of the balance-sheet. It can, therefore, be urged that the amounts set apart under this head would not fall within the meaning of the expression " reserve " contained in the Companies Act particularly having regard to the extended meaning of the word " liabilities " as set out in sub-cl. (3) of r. 7 of Pt. III of Sch. VI to the Companies Act. Sri Desai, learned counsel for the Corporation, sought to get out of this situation by raising two contentions. His first contention was that the Explanation to r. 1 of Sch. II to the Act covers only a case where certain amounts stand to the credit of an account described as " current liabilities and provisions " in the balance-sheet of the company and not to a case where the amount or amounts are shown under the heading "reserve" in the company's balance-sheet. The second point urged by him is that even assuming that it is not the description or the ....
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.... 248, the learned judges observed that the Explanation to r. 1 of Sch. II to the 1964 Act was only for the removal of doubts and not that, in order that the Explanation should apply, it should be shown that, in the balance-sheet of the company for the relevant period, certain items falling under the heading " Current liabilities and provisions " have been shown in the column relevant to " liabilities in the form of balance-sheet or that the items are to be of the nature of item 5 or 6 or 7 falling under the heading " Reserves and Surplus ". The court pointed out that the item of Rs. 53,338.55, which was in issue before the court, did not at all appear in the column of liabilities in the balance-sheet for the relevant year but appeared under the heading " Reserves and Surplus " and as such the question of applying the Explanation to the facts of the case did not arise. Here, it seems to us, and we say so with respect, that the court was under a slight misapprehension regarding the interpretation of the Explanation in the context of the form of balance-sheet prescribed under the company law, for, any item shown in the balance-sheet under the head " Reserves and Surplus " is an item t....
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....ve ", all items shown under either of the two headings " A " and " B " of the heading " Current Liabilities and Provisions ". The reference to the column relating to " Liabilities " made a little later in the Explanation is not a reference to the heading " Current Liabilities " shown under the sub-heading " A " but to the general column of liabilities as opposed to the column relating to assets in the form of balance-sheet. Once, therefore, an item is recognised to fall under the headings " Current liabilities " or " Provisions " or is one of the stipulated items referable to the heading " Reserves and Surplus ", it would certainly be liable to be excluded from being treated as reserve. We, are, therefore, unable to agree with these aspects of the two judgments relied upon by Sri Desai. We are also unable with respect to agree with what has been referred to in the Bombay decision as the " technical approach which seems to suggest that the question whether an item is to be treated as a " Current liability " or " provision " or a " reserve and surplus " should be decided on the basis of the manner in which it is exhibited in the balance-sheet. The Explanation does not confine itse....
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....finition of the word " liability " in cl. (1), an item will be in the nature of a provision if it is an amount retained by way of providing for any known present, future, disputed or contingent liability, the amount of which cannot be determined with substantial accuracy. The argument of the learned counsel is that though all liabilities, present or future, certain or contingent, admitted or disputed, can all be treated as liabilities for the purpose of this definition, the real emphasis in the definition has to be attached to the word " known " used in cls. (a) and (b) of r. 7(1). Learned counsel contends that the introduction of this word qualifies the otherwise very wide scope of the definition and restricts it only to cases of provision for a liability, the existence of which is known, as on the date of the balance-sheet. In support of this contention, again, learned counsel refers to the Bombay decision earlier cited [1977] 107 ITR 241. At p. 250, the learned judges observed that although the expression " liability " is defined as inclusive of contingent liabilities even so such contingent liabilities must be known contingent liabilities. That such would be the correct positio....
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.... the 1964 Act. After referring to the dictionary meaning of the expression " reserve " and the decisions of the Supreme Court and certain other High Courts, the court held that in the case of gratuity no current liability had arisen in the accounting year and observed (p. 77): " In regard to a liability which has not arisen (in the sense no doubt has become due from the assessee by reason of retirement) any amount reserved does not have the character of amount reserved by way of provision to meet a liability. The argument of counsel for the revenue is that even such a reserve is in the nature of liability mentioned in the heading 'Current liabilities and provisions'. It is easy to see that it is neither current liability nor one in the nature of such liability. If 'provision' has to be understood in relation to a balance-sheet for the current year as one for meeting the liabilities of the year, as we feel it should be, it is evident that the disputed reserve is not in the, nature of a provision. Counsel for the revenue argues that the term 'contingencies' referred to in the form of balance-sheet has not to be related to the year in question but to any liability that may arise at....
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....ict the scope of this expression by reference to the known financial position of the company, i. e., as it stands on a particular date and as a result of the financial working of the company daring the earlier accounting year. In the Orissa Cement's case decided under the Super Profits Tax Act, we pointed out that the expression " known " should be understood as referring to an existing liability and not to a future liability. But that was because the definition in the Companies Act and the terms of the Explanation in the Act of 1964 were not available there. But even in the context of the 1964 Act, it appears to us that the whole object of the provision would be defeated if one were to consider even the setting apart of sums towards future liabilities, which may or may not arise at all as amounting to provisions. As pointed out by the Bombay and the Kerala High Courts it is necessary in the context to restrict the operation of this definition only to cases where there is known liability, i. e., a liability referable to an outstanding transaction or an event that has taken place as a result of which it is definitely probable that a liability will be fastened on the company. For ins....