The judgment of the court was delivered by
SUHAS C. SEN J.---The point that falls for determination
in this case is whether a sum of Rs. 79 lakhs representing debenture redemption
reserve was includible in computing the capital of the assessee-company for the
purpose of the Companies (Profits) Surtax Act, 1964.
The High Court (see [1986] 160 ITR 716), took the view
that the amount set apart to redeem the debentures has to be treated as "
provision " and not as " reserve ". The facts stated by the High
Court in this regard are as follows (see [1986] 160 ITR 716, 721) :
" From the balance-sheets for the said periods, we
find that in the calendar year 1965, the debenture redemption reserve was Rs.
79,00,000. However, in the next calendar year 1966, which is relevant to the
assessment year 1967-68, the figure of debenture redemption reserve has gone up
to Rs. 1,12,00,000. A perusal of the balance-sheet further shows that the
assessee-company had floated and actually issued 6 1/2 per cent. secured
redeemable mortgage debentures, as pointed out earlier, against the security of
land, buildings and machinery of the company and a floating charge on the
undertaking. None of these debentures appear to have been redeemed during the
relevant previous years. There is no dispute regarding any of these facts. In
these circumstances, it clearly appears to us that the debenture redemption
reserve must be regarded as a provision made by the assessee-company to enable
it to redeem the said debentures when they became due for redemption. Since the
aggregate amount of such debentures is much larger than the amount of the
debenture redemption reserve, we fail to see how it can be said that there was
any excess as such in this appropriation which could be taken as reserve. It is
true that all the debentures had not become redeemable during the relevant
previous years, but that does not make any difference because an amount set
aside to meet a future liability, which was certain to come into existence, as
in this case, must be regarded as a provision and not as a reserve. "
We are of the view that the High Court has come to the
correct conclusion. The basic principle is that an amount set apart to meet a
known liability cannot be regarded as " reserve ". " Provision
" and " reserve " have been defined in Part III, Schedule VI, to
the Companies Act itself :
" 7. (1) For the purposes of Parts I and II of this
Schedule, unless the context otherwise requires,---
(a) the expression 'provision' shall, subject to
sub-clause (2) of this clause, mean any amount written off or retained by way of
providing for depreciation, renewals or diminution in value of assets, or
retained by way of providing for any known liability of which the amount cannot
be determined with substantial accuracy;
(b) the expression 'reserve' shall not, subject as
aforesaid, include any amount written off or retained by way of providing for
depreciation, renewals or diminution in value of assets or retained by way of
providing for any known liability;
(c) the expression 'capital reserve' shall not include any
amount regarded as free for distribution through the profit and loss account;
and the expression 'revenue reserve' shall mean any reserve other than a capital
reserve;
and in this sub-clause the expression 'liability' shall
include all liabilities in respect of expenditure contracted for and all
disputed or contingent liabilities.
(2) Where---
(a) any amount written off or retained by way of providing
for depreciation, renewals or diminution in value of assets, not being an amount
written off in relation to fixed assets before the commencement of this Act; or
(b) any amount retained by way of providing for any known
liability;
is 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 purposes of this Schedule as a reserve and not as a provision. "
The definition clearly indicates that if an amount is
retained by way of providing for any known liability that amount shall not be
treated as a reserve. Clause 7(2)(b) makes it clear that only an amount which is
in excess of what is reasonably necessary for meeting a known liability shall be
treated as reserve and not as provision. The directors will have to form an
opinion as to what is reasonably necessary for meeting the known liability of a
company. The opinion of an accountant or an auditor or a lawyer is quite
immaterial for this purpose.
The finding of fact in this case is that the amount set
apart for redemption of debentures is less than the company's liability on this
account. Therefore, the answer to the question raised must be that the amount of
Rs. 79 lakhs representing debenture redemption reserve cannot be included in the
capital of the company for the purpose of surtax assessment. The facts stated in
the judgment of the High Court go to show that the amount was not larger than
the amount which had to be paid for redemption of the debentures. Therefore,
there is no question of any excess provision of this case.
In the case of Vazir Sultan Tobacco Co. Ltd. v. CIT [1981]
132 ITR 559 (SC), it was held that " provision " and " reserve
" had not been defined under the Companies (Profits) Surtax Act, 1964.
Therefore, the two concepts " reserve " and " provision "
which are fairly well known in commercial accountancy and which are used under
the Companies Act dealing with preparation of balance-sheets and profit and loss
accounts, will have to be gathered from the meaning attached to them by the
Companies Act itself. Moreover, in Vazir Sultan's case, [1981] 132 ITR 559 (SC),
it was pointed out that even if a sum of money which had been set apart for a
certain purpose was held not to be a " provision ", it did not
automatically follow that it would be a reserve. It was held :
" But it is clear beyond doubt that if any retention
or appropriation of a sum is not a provision, that is to say, if it is not
designated to meet depreciation, renewals or diminution in value of assets or
any known liability, the same is not necessarily a reserve. We are emphasising
this aspect of the matter because during the hearing almost all counsel for the
assessees strenuously contended before us that once it was shown or became clear
that the retention or appropriation of a sum out of profits and surpluses was
for an unknown liability or for a liability which did not exist on the relevant
date, it must be regarded as a reserve. The fallacy underlying the contention
becomes apparent if the negative and non-exhaustive aspects of the definition of
reserve are borne in mind. "
It has been contended by Shri T. A. Ramachandran on behalf
of the assessee that what is set apart for meeting the current year's known or
estimated liability will be " provision ". An amount set apart for
future use will not be " provision ". This argument is without any
merit. It goes against the very definition of " provision " and "
reserve " provided by the Companies Act. In the form of balance-sheet in
Schedule VI of the Companies Act provisions have to be made, inter alia, for
contingencies, provident fund scheme, insurance, pension and staff benefit
schemes. Amounts set apart for the aforesaid purposes will mostly be for future
use. The question of payment of pension or provident fund can only arise when an
employee retires.
Mr. T. A. Ramachandran advanced another argument that
there was no present liability to pay any amount to the debenture-holders. That
liability will arise only when the amount falls due for payment. Therefore,
there was no existing liability for redeeming the debentures in the relevant
year of account.
We are unable to uphold this argument. The liability to
repay arises the moment the money is borrowed. The amount borrowed may be
repayable immediately or in future. The date of repayment of loan may be
deferred by agreement but the obligation or the liability to repay will not
cease on that account. The obligation is a present obligation; debitum in
praesenti, solvendum in futuro. This aspect of the matter was explained in the
judgment of this court in Kesoram Industries and Cotton Mills Ltd. v. CWT [1966]
59 ITR 767.
By issuing the debentures, the company had taken a loan
against the security of its assets. This loan may not be repayable in the year
of account. But the obligation to pay the loan is a present obligation. Any
money set apart in the accounts of the company to redeem the debentures must be
treated as moneys set apart to meet a known liability. The debentures will have
to be shown in the company's balance-sheet of the year as " liability
".
In the case of CIT v. Peico Electronics and Electricals
[1987] 166 ITR 299, the Calcutta High Court held that the debenture redemption
reserve will have to be treated as a " reserve " and not "
provision " because, none of the debentures became redeemable during the
accounting period. The liability to redeem the debentures was a future
liability. The debentures had been separately shown in the balance-sheet as a
liability. The reserve had been created by appropriation of profits and not by
way of a charge on the revenue.
We are of the view that this approach is erroneous and
overlooks the definitions of " provision " and " reserve "
given in the Companies Act. The debentures were nothing but secured loans.
Merely because the debentures were not redeemable during the accounting period,
the liability to redeem the debentures did not cease to exist. It was redeemable
or repayable at a future date. But it was a known liability. In the form of
balance-sheet prescribed by the Act in Schedule VI, the secured loans have to be
shown under the heading " liabilities ". Secured loans include (1)
debentures, (2) loans and advances from banks, (3) loans and advances from
subsidiaries, and (4) other loans and advances. The secured loans might not be
immediately repayable, but the liability to repay these loans is an existing
liability and has to be shown in the company's balance-sheet for the relevant
year of account as a liability. Amounts set apart to pay these loans cannot be
" reserve ". The interpretation clause of the balance-sheet in
Schedule VI of the Companies Act specifically lays down that reserves shall not
include any amount written off or retained by way of providing for a known
liability.
The Delhi High Court in the case of CIT v. Modi Industries
Ltd. (No. 2) [1992] 197 ITR 655 also took the view that the amount set apart out
of the profits to redeem the debentures had to be treated as reserves because,
there was no liability in the current year to redeem the debentures.
We are unable to agree with this view for the reasons
given earlier in the judgment.
Apart from this, the argument that found favour with the
courts in the cases of Peico Electronics and Electricals [1987] 166 ITR 299
(Cal) and Modi Industries Ltd. (No. 2) [1992] 197 ITR 655 (Delhi), that if the
retention or appropriation of a sum out of profits and surpluses was for an
unknown liability or for a liability which did not exist on the relevant date it
must be regarded as a " reserve ", was specifically rejected by this
court in Vazir Sultan's case, [1981] 132 ITR 559.. This argument of the assessee
was held to be fallacious.
There is another aspect of this case. In the prescribed
form of balance-sheet, under the heading " Reserves and surpluses "
seven types of reserves have to be shown :
(1) Capital reserves,
(2) Capital redemption reserve,
(3) Share premium account,
(4) Other reserves,
(5) Surplus, i.e., balance in profit and loss account.
(6) Proposed additions to reserves,
(7) Sinking funds.
However, for the purpose of computation of capital of a
company under the Companies (Profits) Surtax Act, 1964, items Nos. (5), (6) and
(7) will not be treated as reserves. The Second Schedule to the Surtax Act lays
down the rules for computation of the capital. Rule 1 contains an Explanation to
the following effect :
" 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. "
In Batliboi's Advanced Accountancy, 27th edition, page
678, the nature of a sinking fund is explained as under :
" Sinking fund.---A sinking fund is a fund created
with the object of providing means for the redemption of liabilities like
debentures or any other loan. It is formed by setting aside, half-yearly or
yearly, a fixed sum of money for a definite period, such sum to be invested at
compound interest, so that at the end of the period, the annual amounts, with
accumulations of interest, will be sufficient to discharge a prescribed loan. In
such a case, the amount set aside should not be debited to Revenue Account but
to a Net Revenue Account or Profit and Loss Appropriation Account, as being
rather in the nature of an allocation of profits than a charge against them.
"
A sinking fund created for redemption of debentures will
not be treated as a reserve even though (1) it has to be shown as " reserve
" in the balance-sheet and (2) the amount kept in this fund is in the
nature of allocation of profits and not a charge against them. It is difficult
to see, in the context of this rule in the Second Schedule, why a debenture
redemption reserve is to be treated as " reserve " on the ground that
the amounts set apart for redemption of debentures are not in the nature of a
charge against profits but merely appropriation of profit. In Peico Electronics
and Electricals' case, [1987] 166 ITR 299 (Cal), one of the grounds which
weighed with the court was the argument that the sinking fund has to be utilised
by making investments and did not form part of the working capital of the
company but the amount lying to the credit of the debenture redemption reserve
was available to the company to be used as working capital.
We fail to comprehend this distinction. What has to be
computed under rule 1 of the Second Schedule to the Surtax Act is the capital of
the company and not its working capital. The amount shown as sinking fund may be
invested in a fruitful way so that the principal and gains from the investments
taken together will enable the company to pay off its debts. Investment of
monies standing to the credit of the sinking fund is nothing but utilisation of
the company's assets for the discharge of its liabilities. There is no rational
explanation why a sinking fund for redemption of debentures will not be a
reserve but a debenture redemption reserve created with the same purpose will be
treated as reserve and included in the computation of capital of the company for
surtax purposes. A construction which leads to absurdity should be avoided.
The basic principle is that any amount retained by way of
providing for a known liability will not be " reserve ". Explanation
to rule 1 of the Second Schedule to the Surtax Act takes this principle to its
logical conclusion by providing that even a sinking fund, which has to be shown
as a reserve in the prescribed form of balance-sheet, will not be treated as
" reserve " for the purpose of computation of capital.
It is further to be noted that the surplus and unallocated
balance in the profit and loss account has been specifically excluded from
" reserves " for computation of capital under the Surtax Act.
Therefore, availability of the amount for utilisation as working capital of the
company or for distribution of dividend cannot be a criterion for deciding
whether a particular amount retained from the profits of the company will be
treated as its reserve or not.
In the premises, we are of the view that the judgment
under appeal was rightly decided. We are unable to uphold the contrary decisions
in the cases of Peico Electronics and Electricals [1987] 166 ITR 299 (Cal) and
Modi Industries Ltd. (No. 2) [1992] 197 ITR 655 (Delhi).
This appeal is, therefore, dismissed. There will be no
order as to costs.
Civil Appeal Nos. 2 of 1995, 1998 of 1989, 432 of 1989 and
433 of 1989 :
Appeals are dismissed in view of the above decision. There
will be no order as to costs.
Civil Appeal No. 2970 of 1981 :
In this appeal we are concerned with the following
question :
" Whether, on the facts and in the circumstances of
the case, the sums of Rs. 38,98,970, and Rs. 6,66,159 constituted reserve and
was required to be taken into account in the computation of the capital under
the Super Profits Tax Act, 1963 ? "
However, we are concerned in this appeal only with the
amount of Rs. 6,66,159, which was appropriated to gratuity reserve. The question
is whether this should be treated as reserve or provision. The point is well
settled by the decision of this court in the case of Vazir Sultan [1981] 132 ITR
559. The answer to the question will be that the amount of Rs. 6,66,159 will
have to be treated as provision and not reserve. We answer the question
accordingly. The order of the High Court to the above extent is set aside.
A point has been taken on behalf of the respondents that
the amount was more than what was actually required to be set apart as liability
for gratuity. We are not expressing any opinion as to that because that is a
question of fact. It does not appear from the High Court's order or the question
raised that this point was at all in issue before the court or the Tribunal.
The assessee can raise this question, if it can lawfully
do so, before the Tribunal. The appeal is allowed.
