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Judgment
Sabyasachi Mukharji, J.—In this reference u/s 256(1) of the income tax Act, 1961 for the assessment year 1965-66, the Tribunal has referred to us the following question: Whether, on the facts and circumstances of the case, the Tribunal was right in holding that in the computation of capital, the assessee was not entitled to benefit of deduction of proposed dividend in terms of section 2(8) of the Companies (Profits) Surtax Act, 1964 and the Second Schedule thereunder?
After hearing the parties and considering the facts of the case, it appears to us that it will be more appropriate to reframe the question to bring out the correct controversy in the following manner:
Whether, on the facts and in the circumstances of the case, the Tribunal was right in holding that in the computation of capital the company was not entitled to the benefit of deduction of proposed dividend from its cost of investments in terms of clause (ii) of rule 2 of the Second Schedule of the Companies (Profits) Surtax Act, 1964?
Therefore, the question before us is whether in the computation of capital it is proper to deduct the proposed dividend from its cost of investment in terms of clause (ii) of rule 2 of the Second Schedule of the Companies (Profits) Surtax Act, 1964 (hereinafter referred to as "the Act"). In order to appreciate the controversy it would be necessary to refer to certain facts. The assessee is Duncan Brothers & Co. Ltd. and the accounting year of the assessee ended on 31-12-1964, corresponding to the assessment year 1965-66. In the proceeding for the assessment to surtax, the appropriate Tax Officer held that for the purpose of computation of capital the proposed dividend could not be treated as reserve or surplus. It would be appropriate to set out the relevant portion of the order of the ITO. In the order he computed the surtax as follows:
Surtax assessment is completed as below:
Rs.
Rs.
Total income assessed
48,86,730
Less:
Donations
11,586
Dividend from Indian companies
4,34,604
Rebate on export profit
8,364
4,54,554
(A)
44.32,176
23,12,970
Less : Tax
Less:
Tax on Indian dividends @ 25%
1,02,764
Rebate
26,489
76,295
22,36,675
97,200
Tax on excess dividend
(B)
21,39,475
Chargeable profits (A)-(B)
22.92,701"
He deducted donations and dividend from Indian company amounting to Rs. 4,34,604 and after certain other deductions, with which we are not concerned, he arrived at the chargeable profit at Rs. 22,92,701. From that he deducted the statutory deduction of the capital. He took capital as computed by the assessee as Rs. 1,32,41,970. This computation of capital would be clear if we go to the break up of the computation, which has been handed over to us on behalf of the assessee and is not disputed.
COMPUTATION OF CAPITAL EMPLOYED FOR SURTAX PURPOSES FOR ASSESSMENT YEAR 1965-66
Rs.
Paid up share capital
1,63,00,000
Share premium account
18,00,000
Development rebate reserve
87,000
General reserve
83,00,000
Investment reserve
35,00,000
Capital redemption reserve
15,00,000
Contingencies reserve
45,00,000
(sic) 2,89,67,000
Less : Cost of investments in shares in Indian companies
(A) 2,54,58,650
Rs.
Deduct:
Unsecured loans
14,15,377
Acceptances
14,16,353
Outstanding amounts to agency companies
21,10,916
Provision for taxation
31,78,850
Proposed dividend
15,90,000
Profit & Loss account balance
22,124
97,33,620
Capital employed
(B)
1,57,25,030
(A-B)
1,32,41,970
Statutory deduction at 10 per cent of above
13,24,197"
Thereafter, the ITO observed that the claim of the deduction from the investment in Indian company was disallowed as being neither reserve nor surplus and also provision for taxation and the proposed dividend were similarly disallowed by the ITO.
Being aggrieved by the aforesaid order of the ITO, the assessee went up in appeal before the AAC. The AAC held, inter alia, as follows:
It is pleaded that provision for taxation and proposed dividend should be deducted from the cost of investment under rule 2 of the Second Schedule. In appeal [IT Appeal No. 20 (Cal.) of 1969-70] for the assessment year 1964- 65, vide order dated 16-11-1971 of the income tax Appellate Tribunal Bench, Calcutta, it has been held that provision for taxation and the proposed dividend are not reserve and could not be deducted in computing the capital, treating the amounts as reserves. However, now in the same order it has been held that proposed dividend is surplus and the surplus has to be deducted from investment in working out the capital.
Being aggrieved by the said order, the revenue went up in appeal before the Tribunal and the Tribunal after noting the rival contentions and the relevant sections observed, inter alia, as follows:
Thus, our conclusion is that the amount standing to the credit of proposed dividend cannot be treated as reserve or fund or surplus and, thus, it cannot be taken into account for the purpose of calculating the capital under Second Schedule of the Companies (Profits) Surtax Act, 1964. The amount standing to the credit of proposed dividend cannot be available for the purpose of capital or assets of the company.
Therefore, the question as indicated before has been referred and we have reframed the question that brings out the real controversy. Therefore, the short question, is whether the proposed dividend could be considered to be surplus or reserve rather funds, in the hands of the company in order to be entitled to deduction under clause (ii) of rule 2 of the Second Schedule. Now the scheme of clause (ii) of rule 2 has been the subject matter of several judicial interpretations and it is not necessary for us to refer to the numerous decisions. We may point out that under rule 1 of the Second Schedule in terms of section 2(8) of the Act, which defines the statutory deduction, one of the items to be taken into computation of the capital is:
(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), or the income tax Act, 1961 (43 of 1961).
Rule 2 stipulates:
Where a company owns any assets the income from which in accordance with clause (iii) or clause (vi) and clause (vii) of rule 1 of the First Schedule is required to be excluded from its total income in computing its chargeable profits, the amount of its capital as computed under rule 1 of this Schedule shall be diminished by the cost to it of the said assets as on the first day of the previous year relevant to the assessment year in so far as such cost exceeds the aggregate of-
(i) ** ** **
(ii) the amount of any fund, any surplus and any such reserve as is not to be taken into account in computing the capital under rule 1.
The question is whether the proposed dividend would come within the category of any fund, any surplus or any such reserve which is entitled to deduction under clause (ii) of rule 2 of the Second Schedule. We may incidentally point out that the expression "reserve" in clause (ii) of rule 2 of the said Act uses the expression "such" indicating such type of reserve which comes under rule 1 of the Second Schedule. The Supreme Court has said that such item would not come into the computation of capital. The Supreme Court in a judgment in the case of Vazir Sultan Tobacco Co. Ltd. v CIT [1981] 7 Taxman 28 had the occasion to consider some of the aspects. The Supreme Court observed at paragraph 8 of the decision as follows:
The expression ''reserve'' has not been defined in the Act and, therefore, one would be inclined to resort to its ordinary natural meaning as given in the dictionary but it seems to us that the dictionary meaning, though useful in itself, may not be sufficient, for the dictionaries do not make any distinction between the two concepts ''reserve'' and ''provision'' while giving their primary meanings whereas in the context of the legislation with which we are concerned in the case of a clear distinction between the two is implied. According to the dictionaries (both Oxford and Webster), the applicable primary meaning of the word ''reserve'' is: ''to keep for future use or enjoyment: to set apart for some purpose or end in view: to keep in store for future or special use: to keep in ''reserve'', while ''provision'' according to Webster means ''something provided for future''. In other words according to the dictionary meanings, both the words are more or less synonymous and connote the same idea. Since the rules for computation of capital contained in the Second Schedule proceeded on the basis of the formula of capital plus reserves-a formula well-known in commercial accountancy, it becomes essential to know the exact connotation of the two concepts ''reserve'' and ''provision'' and the distinction between the two as known in commercial accountancy. Besides, though the expression ''reserve'' is not defined in the Act, it cannot be forgotten that it occurs in a taxing statute which is applicable to companies only and to no other assessable entities and as such the expression will have to be understood in its ordinary popular sense, that is to say, the sense or meaning that is attributed to it by men of business, trade and commerce and by persons interested in or dealing with companies. Therefore, the meaning attached to these two words in the provisions of the Companies Act, 1956 dealing with preparation of balance sheet and profit and loss account would govern their construction for the purposes of the two taxing enactments. We might mention here that in Commissioner of Income Tax Vs. Century Spg. and Mfg. Co. Ltd., this Court after referring to the dictionary meaning of the expression ''reserve'' observed: ''What is the true nature and character of the disputed sum (sum allegedly set apart) must be determined with references to the substance of the matter, and went on to determine the true nature and character of the disputed sum by relying upon the provisions of the Indian Companies Act, 1913, the form and the contents of the balance sheet required to be drawn up and regulation 99 in Table A of the First Schedule." (p. 33)
Then the Supreme Court referred to the decision of the Supreme Court in the case of Metal Box Co. of India Ltd. v. Their Workmen [1969] 73 ITR 67. The Supreme Court thereafter went on to observe in paragraph 10 as follows:
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 ''provision'', it can never be a reserve but it does not follow that if the retention or appropriation is not a provision it is automatically a reserve and the question will have to be decided having regard to the true nature and character of the sum so retained or appropriated depending on several factors including the intention with which and the purpose for which such retention or appropriation has been made because the substance of the matter is to be regarded and in this context the primary dictionary meaning of the term ''reserve'' may have to be availed of. 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 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. Having regard to type of definitions of the two concepts which are to be found in clause 7 of Part III, the proper approach in our view would be first to ascertain whether the particular retention or appropriation of a sum falls within the expression ''provision'' and if it does, then clearly the concerned sum will have to be excluded from the computation of a capital, but in case the retention or appropriation of the sum is not a provision as defined, the question will have to be decided by reference to the true nature and character of the sum so retained or appropriated having regard to several factors as mentioned above and if the concerned sum is in fact a reserve, then it will be taken into account for the computation of capital." (p. 34)
The Supreme Court in paragraph 23 observed as follows:
It is true that u/s 217 of the Companies Act, the directors can merely recommend that a certain sum be paid as dividend but such recommendation does not result in any obligation or liability; the obligation or liability to pay the dividend arises only when the shareholders at the annual general meeting of the company decide to accept the recommendation and pass a resolution for declaration of the dividend. It is, therefore, open to the directors to withdraw or modify their recommendation at any time before the shareholders accept the same and it is equally open to the shareholders not to accept the recommendation at all or to declare a dividend of an amount lesser than that recommended by directors. In Kesoram Industries'' case (supra), this Court has clarified the aforesaid legal position by observing at page 772 of the report, thus:
''The directors cannot distribute dividends but they can only recommend to the general body of the company the quantum of dividend to be distributed. u/s 217 of the Indian Companies Act, there shall be attached to every balance sheet laid before a company in general meeting a report by its board of directors with respect to, inter alia, the amount, if any, which it recommends to be paid by way of dividend. Till the company in its general body meeting accepts the recommendation and declares the dividend, the report of the directors in that regard is only a recommendation which may be withdrawn or modified as the case may be. As on the valuation date (under the Wealth-tax Act) nothing further happened than a mere recommendation by the directors as to the amount that might be distributed as dividend it is not possible to hold that there was any debt owed by the assessee to the shareholders on the valuation date....''
All that follows from above is that in the instant case the appropriation of the concerned amounts by the board of directors by way of providing for proposed dividend would not constitute ''provisions'', for, the appropriations cannot be said to be by way of providing for any known or existing liability, none having arisen on the date when the directors made the recommendation much less on the relevant date being the first day of the previous year relevant to the assessment year in question. But, as stated earlier this by itself would not automatically convert the appropriations into reserves, regard being had to the negative and non-exhaustive character of the definition of reserve'' given in clause 7(1)(b) of Part III of Schedule VI to the Companies Act. The question whether the concerned amounts in fact constituted ''reserves'' or not will have to be decided by having regard to the true nature and character of the sums so appropriated, depending on the surrounding circumstances, particularly, the intention with which and the purpose for which such appropriations had been made.
In coming to its conclusion, after referring to the different submissions, the Supreme Court observed in paragraph 33 as follows:
It is not possible to accept either of these contentions urged by counsel for the assessee-company. It is true that u/s 205(1) of the Companies Act, it is open to the directors to recommend and the shareholders to approve payment of dividends, either from the current year''s profits or from the past year''s profits. It is also true that on transfer of a portion of current year''s profits to the general reserve the augmented general reserve becomes a conglomerate fund but having regard to the natural course of human conduct of hard headed man of business and commerce it is not difficult to predicate that the dividends would ordinarily be paid out from the current income rather than from the past savings, unless the directors in their report expressly or specifically state that payment of dividends would be made from the past savings. From the commercial point of view if any amount is required for incurring any expenditure or making any disbursement like distribution of dividends in a current year, then ordinarily the same will come out of the current income of the company if it is available and only if the same is insufficient then the past savings will be reported to for the purpose of incurring that expenditure or making that disbursement: such a course would be in accordance with the commonsense point of view. We may point out that this aspect of the matter was not considered by the Andhra Pradesh High Court in Super Spinning Mills Ltd.''s case (supra) and the view of the Bombay High Court in the case of Bharat Bijlee Ltd. (supra) and Marrior (India) Ltd. (supra) commends itself to us. Even in regard to the question of valuing the closing stock the learned authors of the treatise referred to by the counsel for the assessee-company merely indicate three methods for such valuation and it will be open to a commercial concern to avail of any one method. In our view, in the context of the question whether while incurring any expenditure or making any disbursement a commercial concerned will resort to current income or past savings, the normal rule, in the absence of express indication to the contrary, would be to resort to the current income rather than past savings." (p. 43)
Mr. Justice A.N. Sen who delivered a concurrent judgment for different reasons observed as follows:
...I am, therefore, of the opinion that the amount set apart for the payment of any proposed dividend on the basis of recommendation of the Directors cannot constitute reserve for the purpose of computation of the capital of the company. The view that I have taken, to my mind, appears to be in accord with the view earlier expressed by this Court in the decisions to which I have already referred." (p. 50)
Therefore, it appears to us that the Supreme Court was of the view that taking the commercial point of view, the proposed dividend though had not matured into an agreed liability on the first day of the relevant year, was for all practical purposes a liability to be incurred and should not be treated as reserve or surplus available to the company in future. If that is the position, it cannot be considered to be either reserve or surplus and cannot enter into computation of capital and it cannot be for similar reasons, as has been pointed out immediately, treated as surplus or funds in the hands of the company. This view is also in consonance with the views expressed by this Court in the case of Bird & Co. (P.) Ltd. v. CIT 1981 Tax LR 1277, the relevant observations are at page 1278.
Our attention was also drawn to the decision in the case of Duncan Brothers & Co. Ltd. v. CIT [1933] 1 ITR 695 (sic) where the question was whether the provision for taxation could be considered to be reserve in terms of rule 1 and whether it was entitled to deduction. Our attention was also drawn to the unreported decision in IT Reference No. 272 of 1976 in the case of Duncan Brothers & Co. Ltd. v. CIT (the judgment delivered on 4-8-1978), where the Court was concerned with the question whether deduction of provision for taxation and cost of investment in terms of clause (ii) of rule 2 in the Second Schedule, was entitled to or not. The provision for taxation, in our opinion, would stand on a different footing as was explained in the case of Bird & Co. (P.) Ltd. (supra). For the reasons stated above, we are of the opinion that the Tribunal came to the correct conclusion. Therefore, the question, as reframed, must be answered in the affirmative and in favour of the revenue. In the facts and circumstances of the case, the parties will pay and bear its own costs.
C.K. Banerji, J.
I agree.