Bombay H.C : Whether, on the facts and in the circumstances of the case, the amount of Rs. 10,50,385 (pertaining to the customs, authorities’ claim for additional customs duty), was a ‘reserve’ within the meaning of r.1 of the Second Schedule to the SPT Act, 1963 ?

Counsel Appeared

S.E. Dastur, for the Assessee : R.J. Joshi, with V.C. Kotwal, for the Commissioner

KANIA, J. :

This is a reference under s. 19 of the S.P.T. Act, 1963 (referred to hereinafter as “the said Act”, r/w s. 256(1) of the IT Act, 1961, made at the instance of the assessee.

The questions referred to us for our determination in this reference are as follows :

“(1) Whether, on the facts and in the circumstances of the case, the amount of Rs. 10,50,385 (pertaining to the customs, authorities’ claim for additional customs duty), was a ‘reserve’ within the meaning of r.1 of the Second Schedule to the SPT Act, 1963 ?

(2) Whether, on the facts and in the circumstances of the case, the amount of Rs. 1,01,69,824 (pertaining to taxation), was a ‘ reserve ‘ within r.1 of the Second Schedule to the SPT Act, 1963 ?

(3) Whether, on the facts and in the circumstances of the case, the sum of Rs. 1,07,50,000 (pertaining to trade marks), was a ‘reserve’ within r.1 of the Second Schedule to the SPT Act, 1963 ?”

The facts giving rise to this reference are as follows :

(a) The assessee is a limited company. For the asst. yr. 1963-64, with which we are concerned in this reference, the relevant previous year was the year ending on 30th June, 1962, in respect of the computation of its capital as on 1st July, 1961, as per r. 1 of the Second Schedule to the said Act. The assessee claimed that the following amounts should be included in the said capital : (1) Provision for additional customs duty in the sum of Rs. 10,50,385, (2) Provision for taxation in the sum of Rs. 1,01,69,824, and (3) Provision towards depreciation of certain trademarks in the sum of Rs. 1,07,50,000. It appears that there were some disputes between the assessee and the Customs authorities in respect of the levy of customs duty on certain goods imported by the assessee. Provisional assessments were made by the Customs authorities on the assessee. The assessee did not pay the amounts payable under the said provisional assessments, but set aside certain lump sums from year to year. At the end of the asst. yr. 1960-61, the aggregate amount set aside in this manner for the asst. yrs. 1958-59, 1959-60 and 1960-61 was Rs. 10,50,385. These amounts along with certain other amounts were shown in the balance-sheet as on 30th June, 1961, under the head “Provision” as “Provision for additional customs duty”. From the statement of the case it appears that it was stated by the assessee before the Tribunal that these disputes were substantially settled in the year ending on 30th June, 1963, and the amounts had been transferred to the P & L a/c. and thereafter to a reserve. The Tribunal has not stated whether this statement has been accepted by the Tribunal as correct nor is there anything to show that the Tribunal accepted that any particular amount was transferred to the P & L a/c. or thereafter to a reserve account. (b) A sum of Rs. 1,08,00,000 was set aside as provision for taxation on the assessee-company’s profits for the year ending on 30th June, 1961. Out of this amount a sum of Rs. 6,30,176 was paid as advance tax for the asst. yr. 1962-63, and the balance amount as on 1st July, 1961, was Rs. 1,01,69,824. (c) The assessee-company had acquired user rights to the trade mark of Glaxo Laboratories Ltd., U.K., for Rs. 1,50,00,000 for a period of 20 years. Fifteen lakhs shares in the assessee-company of Rs. 10 each were allotted to the said English company as consideration for the purchase of the said trade mark. That sum was shown as a part of the fixed assets of the assessee-company. Every year a sum of Rs. 7,50,000 was set aside. In the year ending on 30th June, 1961, the amount so set aside amounted to Rs. 1,07,50,000. This sum along with depreciation in respect of the other fixed assets was deducted from the total value of the fixed assets and the net amount was shown in the balance-sheet. (b) In computing the capital for the purposes of ascertaining standard deduction under r. 1 of the Second Schedule to the said Act the assessee included the aforesaid three sums. This inclusion by the assessee was not accepted by the ITO as well as the AAC or by the Tribunal. The Tribunal held that the sum of Rs. 10,50,385 as well as the sum of Rs. 1,01,69,824 had been set aside out of the profits of the assessee to provide for known liabilities, and these were in the nature of provisions and not reserves. It further held that the said sum of Rs.

1,07,50,000 represented the provision towards diminution in the value of the trademarks and it was in no way different from the provision made for depreciation in respect of the other assets, and hence the said sum could not be said to be a reserve. It is from this decision of the Tribunal that the aforesaid three questions have been referred to us for determination.

Before going into the contentions of the parties it would be useful to refer to certain relevant statutory provisions. Sec. 4 of the said Act is the charging section and imposes a tax in respect of chargeable profits. Clause (5) of s. 2 defines the expression “chargeable profits” as the total income of an assessee computed under the IT Act, 1961, for any previous year or years, as the case may be, and adjusted in accordance with the provisions of the First Schedule. Clause (9) of s. 2 defines ” standard deduction” as follows: ‘Standard deduction means an amount equal to six per cent. of the capital of the company as computed in accordance with the provisions of the Second Schedule, or an amount of fifty thousand rupees, whichever is greater.”

There are two provisions to this clause which are not material for our purpose. The Second Schedule to the said Act sets out the rules for computing the capital of a company for the purposes of the said Act. The material portion of r.1 in the Second Schedule runs thus : “Subject to the other provisions contained in this Schedule, the capital of a company shall be the sum of the amounts, as on the first day of the previous year relevant to the assessment year, of its paid up share capital and of its reserve, if any, created under the proviso (b) to cl. (vib) of sub-s. (2) of s. 10 of the Indian IT Act, 1922, or under sub-s. (3) of s. 34 of the IT Act, 1961, and of its other reserves in so far as the amounts credited to such other reserves have not been allowed in computing its profits for the purposes of the Indian IT Act, 1922, or the IT Act, 1961 ……”

The submission of Mr. Dastur, learned counsel for the assessee, is that all the said three amounts of Rs. 10,50,385, Rs. 1,01,69,824 and Rs. 1,07,50,000, respectively, which we propose to refer to hereinafter as “the provisions for the customs duty”,” the provision for taxation” and “the provision for trade marks”, respectively, are liable to be included in the capital of the assessee for the purposes of r. 1 of the Second Schedule to the said Act. However, as far as the provision for taxation is concerned, it was conceded by Mr. Dastur that in view of the decision of this Court in Shree Ram Mills Ltd. vs. CIT (1977) 108 ITR 27, question No. 2, which is in respect of the said provision, is concluded against the assessee.

As far as the question regarding the provision for additional customs duty is concerned, it was submitted by Mr. Dastur that this provision was not for any existing liability and that, in any event, the amount in question had been set apart or reserved for a purpose, namely, the payment of additional customs duty, if it was ultimately found that the assessee was liable to pay the same, and hence the amount provided on this account should be treated as a part of the capital of the company for the purposes of the said Act. In this connection, we find that for all practical purposes, this question is concluded against Mr. Dastur by the two decisions which we propose to discuss presently. In Metal Box Company of India Ltd. vs. Their Workmen (1969) 73 ITR 53 : 39 Comp Cas 410 (SC), a question arose before the Supreme Court regarding what could be considered as a “reserve” which would have to be added back while working out the gross profit of a company under the Second Schedule to the Payment of Bonus Act, 1965. The appellant- company had sought to deduct a certain sum, which represented the estimated liability of the company under two gratuity schemes framed by it, from the gross receipts in the profit and loss account. This estimated liability had been worked out on the basis of the actuarial valuation and the company had made a provision for such liability spread over a number of years. The contention of Mr. Chari, who represented the respondents, namely, the workmen of the company, was that the only amount which could be debited from the gross profits shown under the P & L a/c. was the amount actually paid by the company and it was not entitled to debit in that account any amount worked out by it as its estimated liability. One of the questions which arose before the Supreme Court was whether such an appropriation by the company amounted to a reserve or a provision and, if it was a reserve, it had to be added back while computing the gross profits. In this regard, the Supreme Court stated as follows (at p. 67) : “The next question is whether the amount so provided is a provision or a reserve. The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in the balance-sheet by way of deductions from the assets in respect of which they are made, whereas general reserves and reserve funds are shown as part of the proprietor’s interest (see Spicer and Pegler’s Book-keeping and Accounts, 15th edition, page 42.) An amount set aside out of profits and other surpluses, not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet is a reserve, but an amount set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy is a provision (see William Pickles’ Accountancy, second edition, page 192; Part III, cl. 7, Schedule VI to the Companies Act, 1956, which defines ‘provision’ and ‘ reserve ‘).”

We may point out that these observations are clearly applicable to the present case, because, as in the case of the Payment of Bonus Act, there is no definition of the term “reserve” or of the term “provision” contained in the said Act.

In Shree Ram Mills Ltd. vs. CIT (1977) 108 ITR 27 (Bom), one question pertained to the calculation of the capital of a public limited company for the purposes of the said Act itself, namely, the S.P.T. Act, 1963, in respect of the asst. yr. 1963-64, for which the corresponding accounting year was the calendar year 1962. It was contended by the company that two items were includible in the computation of its capital under the Second Schedule to the said Act, namely, (i) provision for taxation, and (ii) provision made for proposed dividends. It was held by the Division Bench of this Court comprising Kantawala, C.J. and Tulzapurkar, J. (as he then was), that it would be clear from the provision in r. l of the Second Schedule to the said Act, that before any amount or sum qualifies for inclusion in the capital computation of a company the amount or sum must be a “reserve”. On a consideration of the definitions of the expressions “provision” and “reserve” in cl. 7 (1)(a) of Pt. III of Sch. VI to the Companies Act and the decision of the Supreme Court in the case of Metal Box Company of India Ltd. vs. Their Workmen (1969) 73 ITR 53; 39 Comp Cas 410 (SC), it is clear that where an amount is set aside out of profits and other surpluses to provide for any known liability of which the amount cannot be determined with substantial accuracy, the same is a provision; but if the amount so set aside is not designed to meet a liability, contingency, commitment or diminution in value of assets known to exist at the date of the balance-sheet, it will be a reserve. Applying this test, it was held that the amount set aside on account of the provision for taxation from the gross profits of the company would have to be regarded as a provision and not as a reserve. It was pointed out that, the balance-sheet of the company as on 31st Dec., 1961, and the P & L a/c. for the year which ended on 31st Dec., 1961, would be relevant. It could not be disputed that on the expiry of 31st Dec., 1961, the assessee-company incurred the taxation liability in respect of the profits which it had earned during that year, though the exact amount of such liability could not be ascertained with substantial accuracy at that time. The liability for taxation having thus arisen on the expiry of the last day of the year, the setting apart of the sum of Rs. 22,00,000 odd by the board of directors had to be regarded as a provision made for a known and existing liability, the quantification whereof had to be done later. As far as the amounts set aside on account of the proposed dividends were concerned, it was held that, in the first place, a mass of undistributed profits cannot automatically become a reserve and somebody possessing the requisite authority must clearly indicate that the amount had been separated from the general mass of profit with a view to constitute it a reserve; secondly, it should be apparent from the surrounding circumstances that the amount so set apart is in fact a reserve to be utilised in future for a specified purpose on a specific occasion; thirdly, clear conduct on the part of the directors in setting apart a sum from out of the mass of undistributed profits avowedly for the purpose of distribution as dividend would be destructive of making that amount a reserve; and, lastly, having regard to the purpose of the rules framed for computing the capital of the company for the purpose of super profits tax in the Second Schedule to the said Act, the amount so set apart should be available to the assessee for being used in its business. It was further held that the amount set apart for the proposed dividends could not be regarded as a reserve and was not liable to be included in the capital computation of the company under r. 1 of the Second Schedule to the said Act.

If we were to apply the tests laid down in the aforesaid decision, it is clear that the amount set apart as a provision for additional customs duty was set apart to meet an existing liability which could not be ascertained with substantial accuracy at the relevant time, because the matter was sub judice. The facts set out by the Tribunal show that the customs authorities had earlier made certain provisional assessments on the assessee. We totally fail to understand as to how it can ever be said that in respect of these provisional assessments there was no liability on the assessee as contended by Mr. Dastur. It is possible that these provisional assessments might have been set aside in future, but until that was done, there was undoubtedly a liability on the assessee as represented by these provisional assessments. That the assessee disputed the correctness of these provisional assessments and took steps to challenge the same would show that this liability could not be ascertained at that time, but this would not negate the existence of the liability itself. As the amount in question was set apart by the board of directors of the assessee-company or meeting that liability, the directors having authority to so set it apart, it could not be said that the said amount constituted a mere reserve and did not amount to a provision. In fact, turning to the balance-sheet of the assessee-company, which has been tendered before us by consent, we find that an aggregate amount of Rs. 23,56,811 has been shown as the provision for additional customs duty in the balance-sheet as on 30th June, 1961. With regard to this provision for the additional customs duty it was contended by Mr. Dastur that, as the term “reserve” had not been defined in the said Act, we should give it the widest connotation and that the said term should be held to include any amount set aside for any purpose in accordance with the general dictionary meaning of the said term. In this connection Mr. Dastur strongly relied upon the decision of the Supreme Court in CIT vs. Century Spg. and Mfg. Co. Ltd. (1953) 24 ITR 499 (SC), in connection with the computation of the capital of the assesseecompany for the purposes of the Business Profits Tax Act, 1947. In that case in respect of the year ended on 31st Dec., 1945, after making provision for depreciation and taxation, the balance amount of profit of Rs. 5,08,637 was carried to the balance- sheet. This sum was not allowed as a deduction in computing the profits of the assessee-company for the purposes of income-tax: In February, 1946, the directors recommended that out of that amount a sum of Rs. 4,92,426 should be distributed as dividend and the balance of Rs. 16,211 was to be carried forward to the next year’s account. This recommendation was accepted by the shareholders in their meeting on 3rd April, 1946, and the amount of Rs. 4,92,426 was shortly afterwards distributed as dividend. The assessee-company claimed that the sum of Rs. 5,08,637 should be treated as a “reserve” for the purposes of r. 2(1) of the Second Schedule to the Business Profits Tax Act, 1947. In this case the Supreme Court has observed that the term “reserve” is not defined under the Business Profits Tax Act and hence resort must be had to the ordinary natural meaning of the said term as understood in common parlance. The Supreme Court has thereafter gone on to set out the meanings given by various dictionaries of the said term “reserve”. It is interesting to note that after this discussion it was held by the Supreme Court that the said sum of Rs. 5,08,637 did not constitute a “reserve” within the meaning of r. 2(1) of the Second Schedule to the Business Profits Tax Act. In our view, this decision is of no assistance to Mr. Dastur. In the first place, it must be pointed out that in that case the Supreme Court has merely set out the various meanings given to the term “reserve” from two dictionaries, but it did not hold that any one particular meaning out of them is the correct meaning of the said term for the purposes of the Business Profits Tax Act. Moreover, as pointed out by the Division Bench of the Calcutta High Court in A. P. V. Engineering Co. Ltd. vs. CIT (1979) 119 ITR 937 (Cal), the said Act, namely, the SPT Act, 1963, was meant to apply only to companies and not to other categories of assessees. The object of the said Act was to impose a tax on a certain part of the commercial profits of joint stock companies. It would be more appropriate to construe the words and expressions in such a statute according to their commercial sense and not by their dictionary meaning. Even according to the dictionary, one of the basic tests of a reserve is that it is set apart for a future use. Making a provision for a known liability appears to be a use of the fund in presenti and not in futuro. It would be unrealistic to treat an amount earmarked for the payment of a known liability to be something set apart for future use. In any event, such an amount cannot be treated as part of the capital of the assessee-company employed in the business. As pointed out by the Division Bench of the Calcutta High Court, the decision of the Supreme Court in Century Spg. and Mfg. Co. Ltd.(Supra), was not based solely upon the ordinary or dictionary meaning of the expression reserve”. The Supreme Court considered the relevant provisions of the Indian Companies Act, 1913, referred to s. 131 and regln. 99 thereof and came to the conclusion that the item in dispute was not a reserve as understood in the Indian Companies Act, 1913. It was not necessary for the Supreme Court in that case to further distinguish between the concepts “provision” and “reserve” inasmuch as no controversy had arisen on that point. In that case also, in fact, provision had been made by the directors for depreciation and taxation before there was a recommendation for dividend and such provisions had not been claimed to be “reserves.”

The next contention of Mr. Dastur was that, in this case, the amount set apart on account of the provision for additional customs duty was, in any event, in excess of the liability ultimately determined on account of additional customs duty, and to the extent of that excess, at least, it should be regarded as reserve and liable to be included in the capital of the assessee-company. It was contended by Mr. Joshi, learned counsel for the respondent-CIT, that it was not open to Mr. Dastur to raise this contention at all because the question reflected in that contention did not arise from the decision of the Tribunal. It was pointed out by him that this contention was never urged before the Tribunal. There is no finding of the Tribunal as to what was ultimately held to be payable on account of additional customs duty nor has the assessee produced any material before the Tribunal to show as to what was the amount ultimately found to be payable by the assessee on account of additional customs duty. It may further be pointed out that it is not even clear from the record as to what was the source from which the additional customs duty found payable was ultimately paid. All that Mr. Dastur is able to point out to us is that it was stated by the learned counsel for the assessee before the Tribunal that disputes regarding additional customs duty were substantially settled in the year ended on 30th June, 1063, and amounts in question had been transferred in that year to the profit and loss account and thereafter to a reserve account. This is, in our view, in the first place, a mere statement which is recorded, and there is nothing to show that the Tribunal has accepted it as correct. Apart from this, and even on the basis that this statement made by the counsel for the assessee was correct, it would not show as to what the compromise or settlement referred to in the statement was nor does it show as to what was the amount found payable on account of additional customs duty and from where what amount was paid. In view of this, we uphold the objection of Mr. Joshi that it is not at all open to Mr. Dastur to take up this contention before us.

The next question which must be considered is regarding the provision on account of trade marks. In this connection, the submission of Mr. Dastur is that the amount set aside as provision for trade marks could not be regarded as a provision made for depreciating assets. It was submitted by him that, in any event, there was no material before the Tribunal on which it could come to the conclusion that the trade marks in question had depreciated in value. In our opinion, this contention must also be rejected. It may be pointed out that in the balance-sheet of the assessee as on 30th June, 1961, in Sch. III, inter alia, are shown the fixed assets of the assessee-company. One item of these assets, which have been shown, is “trade marks”. These trade marks have been valued at cost at Rs. 1,05,00,000. In the column under the head “Depreciation” an amount of Rs. 1,07,50,000 has been shown against the item “trade marks”. The total value of the fixed assets at cost as on 30th June, 1961, has been shown at Rs. 5,17,55,681. The total amount of depreciation, which includes the depreciation in respect of the trade marks, has been shown at Rs. 2,02,71,547. The value of the fixed assets has been shown at Rs. ,14,84,134, which is the exact figure which would be arrived at by deducting from Rs. 5,17,55,681, which is the value of the fixed assets at cost, the said sum of Rs. 2,02,71,547, being the total amount of depreciation. This would clearly show that the assessee accepted that the trade marks had depreciated in value. We may further point out in this connection that the assessee was not the owner of these trade marks but had merely acquired a right to use them for a period of twenty years. The assessee set apart a sum of Rs. 7,50,000 every year as a provision for depreciation of trade marks. In view of this, there can be no doubt at all that the right to use trade marks, which was the only asset of the assessee in respect of the trade marks, was a depreciating asset and the assessee was making a provision of Rs. 7,50,000 per year to meet the depreciation on the said asset, calculated on the basis of what, we are informed, is known as “the straight line method” of calculating the depreciation. In view of, this, in our opinion, it is impossible to suggest that there was no material before the Tribunal on which the Tribunal could come to the conclusion that the trade-marks were depreciating in value. Moreover, it is equally clear that the amounts set aside by the assessee against this depreciation were in the nature of a provision against the depreciation of a capital asset and not in the nature of a “reserve”. We may note at this stage that it was contended by Mr. Dastur that there is no finding by the Tribunal that the said trade marks had depreciated in value. This contention is, however, totally unsustainable. We find that the Tribunal in para. 29 of its judgment has clearly stated that the said sum of Rs. 1,07,50,000 really represents a provision towards diminution in the value of the trade-marks. Moreover, the Tribunal has, in the said paragraph, gone on to state that there had been a corresponding diminution in the value of the asset, namely, the said trade marks. In view of this, we fail to see how it can be contended that there is no finding by the Tribunal that the said trade marks had diminished in value.

In the result, we answer the questions referred to us as follows :

Question No. 1 : In the negative.

Question No. 2 : In the negative.

Question No. 3 : In the negative.

The assessee must pay to the CIT the costs of this reference.

[Citation : 141 ITR 505]