Madras H.C : Whether, on the facts and in the circumstances of the case and having regard to Explanation under r. 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, the Tribunal was right in holding that the amount standing to the credit of Debenture Redemption Sinking Fund should be treated as `reserve’ only and not as `provision’ and, hence, should be taken as capital for levy of surtax ?

High Court Of Madras

CIT vs. Kasturi & Sons Ltd.

Sections SURTAX SCH. II, SURTAX RULE 1

Asst. Year 1974-75, 1975-76

Thanikkachalam & N.V. Balasubramanian, JJ.

Tax Case Nos. 1786 & 1787 of 1984

14th November, 1996

Counsel Appeared

S.V. Subramaniam, for the Applicant : None, for the Respondent

THANIKKACHALAM, J.:

At the instance of the Department, the Tribunal referred the following question for the opinion of this Court under s. 256(2) of the IT Act, 1961, r/w s. 18 of the Companies (Profits) Surtax Act, 1964 :

“Whether, on the facts and in the circumstances of the case and having regard to Explanation under r. 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, the Tribunal was right in holding that the amount standing to the credit of Debenture Redemption Sinking Fund should be treated as `reserve’ only and not as `provision’ and, hence, should be taken as capital for levy of surtax ?”

For the two asst. yrs. 1974-75 and 1976-77, the assessee’s relevant previous years are the periods from 1st July, 1972 to 30th June, 1973 and 1st July, 1974 to 30th June, 1975 respectively. For the asst. yr. 1974-75, in computing the capital base as on 1st July, 1972, the first day of the previous year under the Second Schedule of the Surtax Act, the ITO excluded the Debenture Redemption Sinking Fund of Rs. 2,93,556 and for the second year, similar figure of Rs. 1,75,000 on the ground that under the Explanation below r. 1 of the Second Schedule, Sinking Fund could not be taken as `reserve’. On assessee’s appeal, the CIT(A), referring to a passage occurring in Pickle’s Accountancy under the caption, “Payment of Debentures at Maturity’ came to the conclusion that the amounts set apart were not `reserves’, but only `provision’ retained by way of providing for a known liability, namely, `the repayment of the debts owing by the company to the debenture holders’. The CIT(A) also referred to the case of Vazir Sultan Tobacco Co. Ltd. vs. CIT (1981) 25 CTR (SC) 186 : (1981) 132 ITR 559 (SC), and concluded that the intention of the company was to set apart certain amounts from year to year so as to enable it to repay the debenture holders and, hence, the appropriation was a provision to meet the known liability. In this view of the matter, the CIT(A) upheld the order passed by the ITO for both the years under consideration.

The assessee appealed to the Tribunal. The relevant facts were that the assessee-company issued 6-1/2% debentures for Rs. 30,00,000 in 1960 and Rs. 15,00,000 in 1965 (trust deeds dt. 6th Jan., 1960 and 7th Jan., 1965). Under the terms of the debenture trust deed, the assessee had to establish a Sinking Fund for the redemption of the debentures and with a view thereto, open an account in its books of accounts called `Debenture Redemption Sinking Fund’ and appropriate in every year during the continuance of this security from the net profits of the company before recommending the declaration of any dividend to its shareholders a sum of not less than one lakh of rupees for the year ending 30th June, 1960 and not less than two lakhs of rupees for every financial year thereafter, credit the same to the said fund and invest from time to time with the previous written consent of the trustees the funds standing to the credit of such fund in such securities, as are authorised by s. 20 of the Indian Trusts Act, 1882 or in the purchase of the assessee’s floated debentures at or below par and credit to such fund all income that may accrue from time to time from such securities (cl. 33(11) of the trust deed, dt. 6th Jan., 1960).

5. The practice of the company was stated to be to adopt the latter method, namely, to repurchase its debentures every year so that as on 30th June, 1973, the total debenture amount outstanding was only Rs. 10,50,667 against the debenture amount issued to the tune of Rs. 45,00,000. The assessee had transferred from the Debenture Redemption Sinking Fund to the General Reserve Fund the value of the debentures purchased and cancelled. The Debenture Redemption Sinking Fund is shown as under : . . Debentures Transfer from Balance Purchased P&L account . . Rs. Rs. Rs. 30-6-1968 Opening balance . 3,00,000 2,83,976 . Tr. . 100 5,84,076 . Purchases 3,16,500 . . 30-6-1969 Tr. . 3,00,000 . . Profit . 580 5,68,156 . Purchases 2,72,800 . 2,95,356 30-6-1970 Tr. . 3,00,000 . . Profit . 63 5,95,419 . Purchases 3,04,500 . 2,90,919 30-6-1971 Tr. . 3,00,000 . . Profit . 75 5,90,994 . TR to GR 3,19,500 . 2,71,494 30-6-1972 Tr. . 3,00,000 . . Profit . 562 5,72,056 . Purchases . . . . TR to GR 2,78,500 . 2,93,556 30-6-1973 Tr. . 3,00,000 . . Profit . 83 5,93,639 . Purchases . . . Before the Tribunal, the assessee contended on the above facts that the amount set apart for the Debenture Redemption Sinking Fund was an amount to be utilised for redemption of debentures appropriated out of profits. The assessee did not invest the amounts from the Sinking Fund in any securities and there was no Sinking Fund investment on the asset side of the balance sheet. Thus, considering the submissions made by both the parties and after noting down the difference between the `reserve’ and the `provision’, in the light of the decision of the Supreme Court in the case of Challapalli Sugars Ltd. vs. CIT 1974 CTR (SC) 309 : (1975) 98 ITR 167 (SC) : TC 29R.273, and in view of the following facts, the Tribunal held that in the present case, the Debenture Redemption Sinking Fund can be treated only as a `reserve’ : (i) Creation of the Debenture Redemption Sinking Fund and the appropriation thereto had been recommended by the directors in their report. (This account is described as `Debenture Redemption Sinking Fund’ in the balance sheet as on 30th June, 1973 and as Debenture Redemption Reserve in the subsequent years, no longer being described as `Sinking Fund’). (ii) The `reserve’ has been created out of the surplus profit of the assessee. (iii) The `reserve’ has been created in the profit and loss appropriation account and has not been created in P&L account. (iv) The `reserve’ so created by the assessee has not diminished the assets of the assessee. (v) The `reserve’ created by the assessee is appearing as `reserve’ under the head `Reserve and Surplus’ in the balance sheet of the assessee. (vi) The `reserve’ has been created by carving out a part of the surplus fund of the assessee. (vii) The Debenture Redemption Reserve would be reduced as and when the payment is made and ultimately the balance, if any, would form part of the General Reserve. (viii) It has not created any charge on the profit and the `reserve’ created by the assessee was not an allowable deduction.

In view of the foregoing reasons, relying upon the decision of the Karnataka High Court in the case of Addl. CIT vs. Bharat Fritz Warner (P) Ltd. (1979) 10 CTR (Kar) 48 : (1979) 118 ITR 25 (Kar), the Tribunal allowed the appeals filed by the assessee for both the assessment years under consideration. The learned senior standing counsel appearing for the Department submitted that under the Explanation below r. 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, Sinking Fund could not be taken as a `reserve’. The Explanation specifically prohibits inclusion as a `reserve’ of 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’ in the form of balance sheet given in Part I of Sch. VI to the Companies Act, 1956. Now, item (5) speaks of the surplus, that is, balance in P&L account, after providing for proposed fund for allocations. Item (6) speaks of proposed additions to `reserve’ and item (7) `Sinking Fund’. Since the Debenture Redemption Sinking Fund is covered by item (7) and, therefore, is specifically prohibited from being included in capital base, the said amount cannot be included. The amount also could be regarded as `provision’ as defined in cl. (7) of Part III of Sch. VI to the Companies Act, 1956, since the amount actually represented provisions for a known liability, namely, the necessity to redeem the debentures within a particular date. According to the assessee, the Redemption Reserve Sinking Fund is actually a `reserve’. This is evident from the fact that transfers are made from this account to `General Reserve’ every year. In other words, from the fact that such transfers are made, the real nature of this account as a `reserve’ is abundantly clear. Further, the amount in question is not represented by any specific or ear-marked investment. Therefore, according to the assessee, the amount set apart for the Debenture Redemption Sinking Fund is an amount to be utilised for redemption of debentures. It is an amount appropriated from profits to prevent the amounts set apart from profits being distributed as dividends until the debentures are repaid. The debentures themselves are shown as liabilities. Hence, any amount set apart from the profit to the Sinking Fund has to be treated as a `free reserve’ includible in the capital base. This question was considered by the Supreme Court in the case of CIT vs. Mysore Electrical Industries Ltd. (1971) 80 ITR 566 (SC), wherein, it was held that plant modernisation and rehabilitation reserves and loan redemption reserves would constitute capital for the purposes of the Act.

Only Sinking Funds, which are created for writing off assets by debiting the P&L account should be excluded from the capital base for surtax purposes and not funds created for appropriation from profits. The company had not invested these monies in any securities, in which case it may be said that since securities are treated as assets, the contra account, namely, the fund account should be excluded. Before the authorities below, reliance was also placed upon the passage occurring in Accountancy by Pickles. We have heard the learned senior standing counsel appearing for the Department and perused records carefully. The assessee—M/s Kasturi & Sons Ltd., are the publishers of `The Hindu’. The Tax Cases relate to surtax assessments made under s. 6(2) of the Companies (Profits) Surtax Act, 1964, for the years 1974-75 and 1976-77. The company borrowed funds by issue of debentures to the total value of Rs. 30,00,000 in 1960 and Rs. 15,00,000 in 1965. The debentures were secured on the assets of the company and a separate trust deed securing debentures was executed in favour of Central Bank Executor & Trustee Co. Pvt. Ltd. and Shri C.H. Bhabha, Vice-Chairman of the Central Bank of India Ltd., Bombay, both of whom were the trustees. In accordance with the directions contained in cl. 33(ii) of the trust deed, the assessee-company had opened an account known as `Debenture Redemption Sinking Fund’. To this account, were transferred from its P&L account, various amounts, being one lakh of rupees in the year ending 30th June, 1960; two lakhs of rupees each in the years ended 30th June, 1961 to 30th June, 1964; three lakhs of rupees each in nine of the succeeding years, commencing from 30th June, 1965 to 30th June, 1973 and Rs. 3,00,411 in the year ended 30th June, 1974. The amounts transferred to the Sinking Fund had earned interest, which was also credited to this account. The company had resorted to purchase of its own debentures at par or below par with the result, there were profits on repurchase of the debentures, in some of the years, which were also credited to this account. As and when debentures are purchased and cancelled, the value of the debentures were transferred by the company from the Debenture Redemption Sinking Fund account to the General Reserve account. Now, as on 1st July, 1972, the company’s accounting year is the year ending June. There was a balance of Rs. 2,93,556 in the Debenture Redemption Sinking Fund account. Similarly, as on 1st July, 1974, there was a balance of Rs. 1,75,000 in this account. The company included Rs. 2,93,556 in the capital base, as an item of reserve in respect of its assessment for the year 1974-75. Similarly, it included the sum of Rs. 1,75,000 in its capital base in the assessment for the year 1976-77. According to the Department, under Explanation below r. 1 of the Second Schedule to the Companies (Profits) Surtax Act, 1964, Sinking Fund could not be taken as a `reserve’. The Explanation specifically prohibits the inclusion as a `reserve’ of 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 of `Reserves and Surplus’ in the `form of balance sheet’ given in Part I of Sch. VI to the Companies Act, 1956. According to the Department, the amount also could be regarded as a `provision’ as defined in cl. 7 of Part III of Sch. VI to the Companies Act, 1956, since the amount actually represented a provision for a known liability, namely, the necessity to redeem the debentures within a particular date.

In the present case, the assessee did not invest the funds standing to the credit of the Debenture Redemption Sinking Fund in any securities; but merely utilised the funds to the credit of the Sinking Fund from time to time in the purchase of the debentures. Thus, in the balance sheet, the Debenture Redemption Sinking Fund, though described as Fund, would, in fact, not be a Fund, since it did not represent any earmarked investment. According to the Tribunal, the result would be that it will not amount to a `provision’; but could be regarded only as a `reserve’ according to the Companies Act. In order to come to this conclusion, reliance was placed upon the judgment of the Supreme Court in the case of Vazir Sultan Tobacco Co. Ltd. (supra). A similar question came up for consideration before this Court in the case of CIT vs. Lakshmi Mills Co. Ltd. (1996) 221 ITR 753 (Mad), wherein, while considering the provisions of r. 1 of Sch. II to the Companies (Profits) Surtax Act, 1964, this Court held that “the fact that the company could use the Debenture Redemption Reserve Fund till the redemption date was a vital fact. The right of user made all the difference and when the right of assessee to use it for business purposes was assured and protected, it was not possible to say that it had been set apart to provide for a known liability. Hence, the Debenture Redemption Reserve was only a `reserve’ and should be included in the capital for purpose of surtax.” A perusal of the order passed by the Tribunal would go to show that it did not consider whether the Redemption Reserve Sinking Fund is also available for the assessee for utilising the same for business purposes, until the redemption date, which is a vital factor for deciding the issue arising in this case, where the Debenture Redemption Sinking Fund is a `reserve’ or `provision’. A perusal of facts would go to show that the amounts transferred to the Sinking Fund had earned interest, which is also credited to this account. The company had resorted to purchase of its own debentures at par or below par, with the result, there were profits on repurchases of the debentures in some of the years, which were also credited to this account. As and when debentures are purchased and cancelled, the value of the debentures cancelled were transferred by the company from the Debentures Redemption Sinking Fund account to the General Reserve account. As on 1st July, 1972, the company’s accounting year is the year ending June, there was a balance of Rs. 2,93,556 in the Debenture Redemption Sinking Fund account. Similarly, as on 1st July, 1974, there was a balance of Rs. 1,75,000 and in this account, the company included, Rs. 2,93,556 in the capital base as an item of `reserve’ in respect of its assessment for the year 1974-75. Similarly, it included a sum of Rs. 1,75,000 in this capital base in the asst. yr. 1976-77. Therefore, it remains to be seen that only the repayment debt, the assessee is utilising the amounts from the Debenture Redemption Sinking Fund for other business purposes by offering the same as `General Reserve Fund’. This would go to show that the Debenture Reserve Sinking Fund was available to the assessee for the use of its business purposes until the debentures are redeemed. In such a case, the Debenture Redemption Sinking Fund was not earmarked for a particular purpose, namely, redemption of debentures. Only in such a case, the Debenture Redemption Sinking Fund would be called a `provision’. If, on the other hand, the amounts from the Debenture Redemption Sinking Fund is available for the use of the assessee-company for its own business purposes, then it would be merely a `reserve’ and it cannot be called as a `provision’. This is to satisfy the test as laid down by the decision of this Court rendered in (1996) 221 ITR 753 (Mad) cited supra.

20. For the foregoing reasons, we hold that there is no infirmity in the order passed by the Tribunal in holding that the Debenture Redemption Sinking Fund is a `reserve’ and not a `provision’. Accordingly, we answer the question referred to us in the affirmative and against the Department in both the assessment years under consideration.

No costs.

[Citation:230 ITR 173]

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