TaxTMI 
TaxTMI 
1996 (3) TMI 128
X X X X Extracts X X X X
X X X X Extracts X X X X
....d such sums, representing reserves, should be included in the capital of the appellant for appropriate relief. The Income-tax Officer rejected the claim. In appeal, the Income-tax Appellate Tribunal allowed the plea of the assessee. The Income-tax Appellate Tribunal, by its detailed order dated January 23, 1980, upheld the plea of the assessee and held that the amounts set apart as reserves are entitled for appropriate relief under rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act. On motion by the Revenue, the Appellate Tribunal referred the following questions of law for the decision of the High Court of Punjab and Haryana (see [1993] 203 ITR 150), which were numbered as Income-tax References Nos. 235 to 238 of 1980 : " (i) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the amounts provided by the assessee for bad and doubtful debts in the balance-sheets of the relevant previous years qualified as reserves for the purpose of clause (xi)(b) of rule 1 of the First Schedule to the Companies (Profits) Surtax Act, 1964, and consequently, allowing yearwise deduction as under : ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....filed the special leave petition in this court against the order of the Appellate Tribunal. All the 13 appeals involve consideration of the same question between the same parties. So, they were heard together and are disposed of by this common judgment. We heard counsel for the appellant-assessee, Mr. A. Subba Rao, and counsel for the respondent-Revenue, Mt. B. S. Ahuja. The statutory provisions, relevant for our purpose, are mentioned hereinbelow : The Companies (Profits) Surtax Act, 1964 (Act 7 of 1964) : " 2. (5) 'chargeable profits' means the total income of an assessee computed under the Income-tax Act, 1961 (43 of 1961), for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule ; ..... (8) 'statutory deduction' means an amount equal to fifteen per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of two hundred thousand rupees, whichever is greater : Provided that where the previous year is longer or shorter than a period of twelve months, the aforesaid amount of fifteen per cent. or, as the case may be, of two hundred thousa....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ever is higher ; . . Explanation. ---Notwithstanding anything contained in any clause of this rule, the amount of any income or profits and gains which is required to be excluded from the total income under that clause shall be only the amount of such income or profits and gains as computed in accordance with the provisions of the Income-tax Act (except Chapter VI-A thereof), and in a case where any deduction is required to be allowed in respect of any such income or profits and gains under the said Chapter VI-A, the amount of such income or profits and gains computed as afore said as reduced by the amount of such deduction." " THE SECOND SCHEDULE (See section 2(8)) RULES FOR COMPUTING THE CAPITAL OF A COMPANY FOR THE PURPOSES OF SURTAX 1. Subject to the other provisions contained in this Schedule, the capital of a company shall be the aggregate of the amounts, as on the first day of the previous year relevant to the assessment year, of --- .... (iii) its other reserves as reduced by the amounts credited to such reserves as have been allowed as a deduction in computing the income of the company for the purposes of the Indian Income-tax Act, 1922 (11 of 1922), o....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e-sheets, is a reserve. In other words, if the amount set apart is designed to meet a liability, contingency, commitment or results in diminution in value of assets, it would be a provision and not a reserve. We have to apply this test here. In paragraphs 20 to 22 of its order, the Appellate Tribunal entered the following findings : " We find that the assessee has not written off or adjust(ed) these amounts provided as reserves for bad and doubtful debts in its profit and loss account that these amounts have not been allowed as a deduction in computing the income of the company for purposes of the Income-tax Act, that these amounts have remained employed in the business of the assessee by way of capital and the assessee has in fact treated these amounts as reserves and not as provisions designed to meet a liability, contingency, commitment, or diminution in the value of assets known to exist at date of relevant balance-sheets. We, therefore, hold that these are amounts which constitute reserve for clause (iii) of rule 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964. In fact, it has been clarified by learned counsel for the assessee, and it has not been....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ably be anticipated by the assessee at the time of the preparation of the accounts, the fund would be treated as a 'reserve'. Whether in respect of bad and doubtful debts, an account could be treated as a reserve or a provision would depend upon the facts and circumstances of each case. Again, whether a particular liability could reasonably and legitimately be anticipated by the assessee on the date of the balance-sheet would be a question of fact to be determined in the circumstances of each case and the nature of the business carried on by the assessee would be a relevant factor. Applying these tests to the case in hand, one cannot lose sight of the fact that the assessee before us is a banking company whose primary business is to lend money. In the very nature of things, it would be reasonable and legitimate for such an assessee to assume that in the course of its business, it is bound to have bad and doubtful debts, for which it may in anticipation make a provision in the balance-sheet by having a separate fund or an account to meet such anticipated liability although its quantum would be determined at some later date. Since such anticipated liability has been equated with a....
X X X X Extracts X X X X
X X X X Extracts X X X X
....n Metal Box Co.'s case [1969] 73 ITR 53 (SC), the court held at page 569, thus : " In other words, the broad distinction between the two is that whereas a provision is a charge against the profits to be taken into account against gross receipts in the profit and loss account, a reserve is an appropriation of profits, the asset or assets by which it is represented being retained to form part of the capital employed in the business." (emphasis supplied). After referring to the relevant provisions of the Companies Act, 1956, regarding the form of balance-sheet wherein the words "reserve and surplus" and "current liabilities and provisions", etc., are dealt with, the court observed, thus : " On a plain reading of clause 7(1)(a) and (b) and clause 7(2) above, it will appear clear that though the term 'provision' is defined positively by specifying what it means the definition of 'reserve' is negative in form and not exhaustive in the sense that it only specifies certain amounts which are not to be included in the term 'reserve'. In other words, the effect of reading the two definitions together is that if any retention or appropriation of a sum falls within the definition of 'p....
X X X X Extracts X X X X
X X X X Extracts X X X X
....res of the reserve. These are : (1) it must be an appropriation of profits, current or accumulated, and not a charge against the profits for the year. (2) The conduct of the parties must bear out that intention. (3) It must not be to set apart to meet any known liability-a liability known to exist on the date of the balance-sheet. Reference in this connection may be made to the observations of this court in Vazir Sultan's case [1981] 132 ITR 559 (pages 569-570)." Again, in CIT v. Saran Engineering Co. Ltd. [1986] 161 ITR 741 (SC), dealing with the question as to whether bad and doubtful debts will constitute a 'provision' or 'reserve', the court stated, thus : " Bad and doubtful debts reserve was created in 1956 through the profit and loss appropriation account. The amount involved was Rs. 5,00,000. It was submitted on behalf of the assessee by Shri Salve that this was created by transfer from the appropriation account and not as a charge against profit. Furthermore, a separate provision was made for bad and doubtful debts which provision was reduced from the value of the assets. It was not the Revenue's case that the provision for bad and doubtful debts provided was less tha....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... amounts set apart towards bad and doubtful debts in these cases are "reserves" qualifying for appropriate relief under rule 1(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act. We are afraid that the High Court has grossly misunderstood the following observations of this court contained in CIT v. Saran Engineering Co. Ltd. [1986] 161 ITR 741: " It may be mentioned that where the liability has actually arisen or is anticipated legitimately by the assessee though the quantum of the liability has not been determined, a fund to meet such present liability cannot be treated as 'reserves'." (emphasis supplied). The High Court has taken the view that the "fund created or a sum of money set apart to meet any liability which the assessee" can reasonably and legitimately anticipate" on the date of preparation of the balance-sheet, is the same, as in a case "where the liability has actually arisen", (a present known liability) and the fund to meet such liability cannot be treated as "reserve". In the view of the High Court, since the assessee is a banking company, it would be "reasonable and legitimate to assume" that in the course of its business, "it i....