ADDITIONAL COMMISSIONER OF INCOME TAX MADRAS I V THIRUMAGAL MILLS LIMITED ADDITIONAL COMMISSIONER OF INCOME TAX MADRAS Vs. ADONI SPINNING AND WEAVING COMPANY LIMITED

JUDGEMENT

(1.) THE two questions that have been referred to this court by the Income-tax Appellate Tribunal, Madras Bench, in T. Cs. Nos. 287 and 289 of 1972 are : " (1) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the dividend equalisation reserve of Rs. 20, 000 is'reserve'and accordingly includible in the capital computation for abatement in the surtax assessment for 1964-65 " (2) Whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the dividend equalisation reserve of Rs. 90, 000 is a'reserve'and accordingly includible in the capital computation for abatement in the super profits tax assessment for 1963-64 "" *

(2.) THE assessee is the same in respect of both these tax cases (T. Cs. Nos. 287 and 289 of 1972 ). In the other tax case, namely, T. C. No. 120 of 1974, in which the assessee is different, the question that has been referred to this court is : "whether, on the facts and in the circumstances of the case, the Appellate Tribunal was right in law in holding that the dividend equalisation reserve of Rs. 2 lakhs credited under the head'reserves and surplus'in the balance-sheet of the assessee-company is'reserve'and as such includible in the capital computation for super profits tax assessment for 1963-64 "" *

(3.) IT is this distinction between "provision" and "reserve" which was emphasised by the Cohen Committee whose recommendation led to the enactment of the Companies Act, 1948, in England. That Committee defined "reserves" as "any amounts which, having been set aside out of revenue or other surplus, are free in that they are not retained to meet any diminution in value of assets, specific liability, contingency or commitment known to exist at the date of the balance-sheet". IT is based on this recommendation that regulation 117 of Table" A"of the First Schedule to that Act provided : " The directors may, before recommending any dividend, set aside out of the profits of the company such sums as they think proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for any purpose to which the profits of the company may be properly applied, and pending such application may, at the like discretion, either be employed in the business of the company or be invested in such investments (other than shares of the company) as the directors may from time to time think fit. The directors may also without placing the same to reserve carry forward any profit which they may think prudent not to divide. " * Paragraph 27 of the English Schedule to the Companies act, 1948, of England gave the meaning of the expressions, "provision", "reserve" and " capital reserve". We are not referring to these definitions in detail because they have been substantially incorporated in the Companies Act, 1956 "the Board may, before recommending any dividend, set aside out of the profits of the company such sums as it thinks proper as a reserve or reserves which shall, at the discretion of the Board, be applicable for any purpose to which the profits of the company may be properly applied, including provision for meeting contingencies or for equalising dividends; and pending such application, may, at the like discretion, either be employed in the business of the company or be invested in such investments (other then shares of the company) as the Board may, from time to time, think fit. " This regulation 87 (1) of Table" A" * of the First Schedule to the Companies Act, 1956, corresponds to regulation 99 of Table "a" of the First Schedule to the Indian Companies Act, 1913. The significant thing to be noticed in our Act is the specified reference to a reserve for equalising dividends. Section 211 of the Companies Act, 1956, provides for the form and contents of balance-sheet and profit and loss account. The said form of balance-sheet is given in Part I of Schedule VI and the form of profit and loss account is given in Part II of Schedule VI. As far as Part I dealing with the balance-sheet is concerned, there is the express heading as "reserves and surplus". Under that heading, several sub-headings are given, such as : " (1) Capital reserves. (2) Capital redemption reserves. (3) Share premium account. (4) Other reserves specifying the nature of each reserve and the amount in respect thereof. Less : Debit balance in profit and loss account (if any ). (5) Surplus, i. e. , balance in profit and loss account after providing for proposed allocations, namely : - Dividend, Bonus or reserves. (6) Proposed additions to reserves. (7) Sinking funds. "paragraph 3 of Part II of Schedule VI states : " The profit and loss account shall set out the various items relating to the income and expenditure of the company arranged under the most convenient heads; and in particular, shall disclose the following information in respect of the period covered by the account : -. . . . . . . . (viii) (a) The aggregate, if material, of any amounts set aside or proposed to be set aside, to reserves, but not including provisions made to meet any specific liability, contingency or commitment known to exist at the date as at which the balance-sheet is made up. (b) The aggregate, if material, of any amounts withdrawn from such reserves. " * Having provided for such particulars, paragraph 7 (1) of schedule VI which comes under the heading "part III-Interpretation" gives the definitions of the terms "provision", "reserve" and "capital reserve", as follows : " 7. (1) Fro the purpose 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. . . . . . " * These statutory provisions will make the distinction between provision" and "reserve" clear and the creation of the " reserve fund "in the present case under the head of "dividend equalisation reserve" will certainly constitute only a "reserve" and not a "provision" even after taking into account the Explanation to paragraph I of the Second Schedule to the Companies (Profits) Surtax Act, 1964. This conclusion of ours derived support from two decisions of the Supreme Court. The first is Commissioner of Income-tax. v. Century Spinning and Manufacturing Co. Ltd. wherein, with reference to regulation 99 of Table "a" of the First Schedule to the Indian companies Act, 1913, the Supreme Court stated (page 505) :" * Reference was made to section 131 (a) and 132 of the indian Companies Act. Section 131 (a) enjoins upon the directors to attach to every balance-sheet a report with respect to the state of company's affairs and the amount, if any, which the recommend to be paid by way of dividend and the amount, if any, which they propose to carry to the reserve fund, general reserve or reserve account. The latter section refers to the contents of the balance-sheet which is to be drawn up in the Form marked F in Schedule III. This form contains a separate head of reserves. Regulation 99 of the 1st schedule, Table A, lays down'that the directors may, before recommending any dividend set aside out of the profits of the company such sums as they think proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for meeting contingencies, or for equalising dividends, or for any other purpose to which the profits of the company may be properly applied. . . . . . . .'The regulation suggests that any sum out of the profits of the company which is to be made as a reserve or reserves must be set aside before the directors recommend any dividend. "thus, it will be seen that according to this judgment a reserve so set apart precedes the distribution of profits by way of dividend. In the above extract, there is a reference to section 131 (a) of the Indian companies Act, 1913. The corresponding section in the Companies Act, 1956, in section 217 (1) which also requires that there shall be attached to every balance-sheet laid before a company is general meeting, a report by its board of directors, with respect to -" * (a) the state of the company's affairs; (b) the amounts, if any, which it proposes to carry to any reserves in such balance-sheet; (c) the amount, if any, which it recommends should be paid by way of dividend. The next decision is Metal Box Company of India Ltd. v. Their Workmen, wherein the Supreme Court observed : "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 P. & L. 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, clause 7, Schedule VI to Companies Act, 1956, which defines provision and reserve ). " *