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Judgment
Jeevan Reddy, J.—There three references are made u/s 27(1) of the Wealth-tax Act. The assessee are equity shareholders in Orient Longman Ltd. In F/C/ No/ 105 of 1981, the assessment years concerned are 1974-75, 1975-76 and 1976-77,where as in the other two references, the relevant assessment years are 1975-76 and 1976-77. The corresponding valuation dates for the said assessment years are Septmber 30, 1973, September 30, 1974,and September 30, 1975, respectively. It is not really necessary to state the facts in all the three cases. It would be enough if we state the facts in R. C. No. 105 of 1981.
The assessee is holding 38, 130 equity shares in Orient Longman Ltd. The shares of this company are not quoted on the stock exchange. The assessee returned the value of the shares as per the auditor''s certificate. But the Wealth-tax Officer did not accept same and proceeded to value of the shares, the Wealth-tax Officer, inter alia, excluded the following two items with which alone we are concerned in these references, viz., (i) provision for bad debts in a sum of Rs. 189,587, and (ii) gratuity liability which the assessee estimated on actuarial basis at Rs. 6,46,359. The Wealth-tax Officer held that the provision made for bad debts is not "a liability" known to exist on the relevant valuation date and, therefore, cannot be deducted from out of the assets. So far as the gratuity amount is concerned, the Wealth-tax Officer held that inasmuch as the company had entered into an agreement with the Life Insurance Corporation under the Group Insurance Scheme, whereunder, on the payment of the prescribed premium, the Corporation alone was liable to and was paying the gratuity to the concerned employees and also because the paid was charged to the profit and loss account, there are no ground to allow the liability computed on the basis of acturarial vbaluation at Rs. 6,43,658 as claimed by the assessee. He held that only the premium amount actually paid by the company and debited in the accounts should be taken into account and nothing more. The Appellate Assistant Commissioner and the Tribunal have confirmed the said reasoning. Hence, these references at the instance of the assessee.
So far as the first question is concerned, a look at the balance-sheet as on September 30, 1984, indicates that the total amount of sundry debts was shown at Rs. 30,09,115.84. Out of this amount, a sum of Rs. 1,89,587.96 was deducted as a provision had to be made on account of doubtful debts. The Revenue''s case is that inasmuch as the debts making up the said amount had not actually been lost to the company by way of bad debts, the said amount cannot be treated as a liabilitym, much less an ascertained liability, on the relevant valuation date and cannot be debited. It is argued that as and when a debt becomes bad and irrecoverable, it is debited to the profit and loss account as per the normal practice. In this matter, however, the said practice has not been followed. The contention of learned standing counsel for the Department before us is that the said provision is in the nature of a suspense account and in effect is a reserve created for absorbing bad debts and accordingly falls under sub clause (c) of clause (ii) of Explanation II to rule 1D of the Wealth-tax Rules. We find it difficult to agree with learned standing counsel. Rule 1D of the Wealth-tax Rules reads as follows;
"The market value of an unquoted equity share of any company, other than an investment company or a managing agency company, shall be determined as follows :-
The value of all the liabilities as shown in the balance-sheet of such company shall be deducted from the value of all its assets shown in that balance-sheet. The net amount so arrived at shall be divided by the total amount of its paid-up equity share capital as shown in the balance-sheet. The resultant amount multiplied by the paid-up value of each equity share shall be break-up value of each unqroted equity share. The market value of each such share shall be 85 per cent. of the break-up value so determined : ...
Explanation II. - For the purposes of this rule - ...
(ii) the following amounts shown as liabilities in the balance-sheet shall not be treated as liabilities, namely ;..."
(c) reserves, by whatever name called, other than those set aprttpwards deprecoatopm ;..."
According to rule 1D for arriving at the value of an unquoted equity share of a company, the value of all liabilities as shown in the balance-sheet of such company shall be deducted from the value of its assets shown in the balance-sheet. and the net amount so arrived at shall be divided by the total amount of its paid-up equity share capital as shown in the balance-sheet. The resultant amount multiplied by the paid up value of each equity share shall be the break-up value of each unquoted equity share. The next step is to arrive at the market value. The market value of each share shall be 85% of the value so determined. The question we have to decide is : Whether the said provision made on account of doubtful debts is a liability within the meaning of the said fuel ? before we deal with the said aspect, it may be appropriate to clear the ground by disposing of the question whether it can be called a " reserve" within the meaning of clause (ii)(c) of Explanation II. In Vazir Sultan Tobacco Co. Ltd., Hyderabad and Others Vs. Commissioner of Income Tax, Andhra Pradesh, Hyderabad, the Supreme Court has pointed out the distinction between "reserve" and "provision" by extracting an observation from Metal Box Company of India Ltd. Vs. Their Workmen, . The extract reads as fpllpws [1987] 132 ITR 576 :
"Contingent liabilities discounted and valued as necessary, can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into consideration. An estimated liability under a scheme of gratuity, if properly ascertainable and its present value is discounted, is deductible from the gross receipts while preparing the profit and loss account. This is recognised in trade circles and there is nothing in the Bonus Act which prohibits such a practice. Such a provision provides for a known liability of which the amount can be determined with substantial accuracy. It cannot, therefore, be termed a ''reserve''. Therefore, the estimated liability for the year on account of a scheme of gratuity should be allowed to be deducted from the gross profits. The allowance is not restricted to the actual payment of gratuity during the year".
Applying the tests evolved by the Supreme Court, it would be evident that the said provision cannot be a "provision :, since it is shown in the balance-sheet by way of deduction from the assets. We are, therefore, of the opinion that the said provision cannot be treated as a "reserve" within the meaning of clause (ii)(c) of Explanation II.
Now, coming back to be the question whether it constitutes a liability, it is true that as on the relevant valuation date, it has not become a bad debt. But the board of directors who are presumed to know the affairs of the company were setting apart a particular specified amount as a provision for bad debts. This is not a case as in Commissioner of Income Tax, Bombay City-VI Vs. Golden Tobacco Co. Ltd., , where a certain ad hoc amount was credited to the doubtful debt reserve each year by setting apart a certain ad hoc amount every year out of the profits. But this is a case where certain specific known debts are put together and the total amount of those specified debts being doubtful, a provision is made in that behalf and the relevant amount deducted from the assets. In the Bombay case aforesaid - upon which reliance was placed not only by the Tribunal but also by learned standing counsel for the Department before us - after a number of years, a major amount which stood accumulated to the doubtful debt reserve was transferred to the general reserves. The principle of the said Bombay decision, in our opinion, has no application herein. There are no reasons for not respecting the decision of the board of directors in this case that certain specified debts have become doubtful and that they are so doubtful that they can be treated as a liability within the meaning of rule 1D of the Wealth-tax Rules. It goes without saying that if and when any part or whole of this amount is recovered, it would be added to the general revenues as on the relevant date. But when the board of directors have, as a matter of managerial decision, set apart the said amount as a provision for bad debts and deducted it from the assets of the company, there is no good reason to ignore the same on the ground that it is not a liability. As we have pointed out above, this is not a case where a certain ad hoc amount was credited every year out of profits towards doubtful debt reserves. Here, certain known debts which had become quite doubtful of recovery had been put together and shown as "a liability" and deducted out of the assets. In such a situation, we are of the opinion that there was no reason or justification for the Department to interfere with the said business decision of the board of directors. We may also mention that there is no allegation that this is a device or that it was not a decision arrived at in the ordinary course of the management of the affairs of the company. We may add that the difference in the value of the shares on this account is hardly sixty paise per share. We are, therefore, of the opinion that the first question referred to us must be answered in favour of the assessee and against the Department.
Now, coming to the second question, we are of the opinion that the stand taken by the Department is correct. The company had entered into an agreement with the Life Insurance Corporation. On their paying the prescribed premium every year, the liability to pay gratuity to the employees of the company was taken over entirely by the Life Insurance Corporation. The company paid only the premium amount to the Life Insurance Corporation and did not actually pay any amount by way of gratuity to any of its employees. Whatever was payable was paid by the Corporation alone. In the circumstances, the contention of the assessee that it is entitled to value the liability on account of gratuity by applying the actuarial principle is unacceptable and has been rightly rejected. We see no reason to differ from the view taken by the Tribunal on this question. Accordingly, question No. 2 is answered against the assessee and in favour of the Revenue.
The references are answered accordingly in the above terms. No costs.