Supreme Court of India
COMMISSIONER OF INCOME TAX (CENTRAL-II), CALCUTTAversusM/S. DUNCAN BROTHERS AND CO. LTD., CALCUTTA
- Citation
- 1996 INSC 234
- Decided
- 13 February 1996
- Disposal
- Appeal(s) allowed
- Bench
- S VERMA
Holding
A provision for taxation is not a fund or reserve and therefore cannot be deducted from the cost of excluded investments for the purpose of computing capital under the Super Profits Tax Act, 1963 and the Companies (Profits) Surtax Act, 1964.
Summary
The assessee, Duncan Brothers & Co. Ltd., claimed that provisions it made for income‑tax liability (Rs 16,48,888 for AY 1963‑64 and Rs 17,52,920 for AY 1964‑65) could either be treated as part of its capital or be deducted from the cost of excluded investments under the Super Profits Tax Act, 1963 and the Companies (Profits) Surtax Act, 1964. The Tribunal held that such provisions were not reserves, funds or surplus but a "perfected debt" and therefore not deductible. The Calcutta High Court upheld the Tribunal on the reserve issue but allowed the deduction claim for both years. The Revenue appealed. The Supreme Court examined the meaning of “fund”, “reserve” and “surplus” in the context of the balance‑sheet and accounting practice, held that a provision for current‑year tax liability is not a fund or reserve, and therefore cannot be deducted from the cost of excluded investments. Consequently, the Court answered the deduction questions in favour of the Revenue and allowed the appeal.
Issues considered
- Whether a provision for taxation made by a company can be treated as a reserve or fund for the purpose of computing capital under Clause (ii) of Rule 1 of the Second Schedule of the Super Profits Tax Act, 1963 and Rule 2 of the Second Schedule of the Companies (Profits) Surtax Act, 1964.
- Whether such provision can be deducted from the cost of excluded investments to augment the capital base of the company.
Legislation cited
- Companies Act, 1956s. Schedule VI (balance‑sheet classification)
- Companies (Profits) Surtax Act, 1964s. Second Schedule – Rule 2 (Clause ii)
- Income Tax Act, 1961s. Section 256(1)
Subjects
provision for taxationcapital computationsuper profits taxfundreservedeductionincome taxaccountingsecond schedulecost of excluded investments
Judgment
A COMMISSIONER OF INCOME TAX (CENTRAL-II), CALCUTIA
v.
MIS. DUNCAN BROTHERS AND CO. LTD., CALCUTTA
FEBRUARY 13, 1996
B [J.S. VERMA, S.P. BHARUCHA AND SUJATA V. MANOHAR, JJ.]
Super Profits Tax Act, 1963/Companies (Profits) Swtax Act, 1964 :
Clause (ii) of Rule 1 of the Second Schedule/Rule 2(ii) of the Second
C Schedule-Provision for taxation-Wliether could be deducted from the cost
of excluded investments so as to augment the capital base-Held: No.
Circulars-Central Board of Revenue-Circular No. J.P. (XV- 5) of
1968 dated 23-1-1968-Applicability of
D Words & Phrases :
'Fund'-Meaning of
For the assessment year 1963-64, the assessee company claimed for
the purposes of Super Profits tax Act, 1963 in the computation of its
E capital, a provision for taxation made by it should be treated as a part of
its capital or as a deduction from the cost of investment. For the assess-
ment year 1964-65, the assessee made a similar claim in respect of a
provision for taxation made by it. This claim was made under the
provisions of the Companies (profits) Surtax Act, 1964. The Appellate
p Assistant Commissioner of Income tax held that the provision for taxation
cannot be considered as a reserve but was to be deducted from the cost of
investments in computing the capital based of the company.
On appeal, the Tribunal held that the provisions for taxation made
in the said two. assessment years was not a reserve which could forni part
G of the capital of the company; that the provisions for taxation was neither
a fund nor a surplus but a "perfected debt" and as such it would not qualify
for a deduction as claimed by the assessee. The Tribunal made a Reference
to the High Court. Of the three questions referred to it, the High Court
answered the first question viz. whether the Tribunal was right in holding
H that 'provision for taxation' was not a reserve to form part of the capital,
492
,,
C.l.T. v. DUNKAN BROS. AND CO. 493
in favour of the Revenue. As regards the other two questions as to whether A
the company was entitled to the benefit of deduction of the amount of
- 'Provision for Taxation' from its cost of investments, in respect of assess-
ment years 1963-64 and 1964-65, the High Court answered in favour of the
assessee. Against this, the Revenue has come in appeal.
B
The Respondent-assessee contended that while the capital involved
in the investment in shares had been deducted in the computation of its
Capital, the amount of such capital deducted should be reduced by the
amount of "any fund, any surplus and any reserve" in terms of clause (ii)
of Rule 1 of the Second Schedule of the Super Profits tax Act, 1963 and
the corresponding clause of Rule 2(ii) of the Second Schedule of the c
Companies (Profits) Surtax Act, 1964.
Allowing the Revenue's appeal, this Court
HELD : 1.1. Since the Second Schedule to both the Acts viz., Super D
Profits Tax Act, 1963 and Companies (Profits) Surtax Act, 1964 pertains
to computing the capital of a company for the purposes of tax under these.
Acts, the terms used in the Second Schedule need to be interpreted in the
context of the balance sheet of a company and it profit and loss account
which will necessarily have to be looked at to ascertain the company's
capital and its profits. The terms used must, therefore, be read in the light E
of the provisions of the Companies Act and how these terms are under-
stood in accounting parlance. [499-C-Dj
1.2. In the instant case there is no systematic accumulation of cash
or any separation of assets to meet future tax liabilities. There is oqly an F·
accounting entry of an exact sum being earmarked for payment df tax
liability arising at· the end of the current accounting years. Such a
provision cannot be con'sidered as a fund. [500-G-H]
13. Circular No. I.P. (XV-5) of 1968 dated 23rd of January, 1968,
issued by the Central Board of Revenue and relied on by the assessee deals G
with the treatment of an amount standing to the credit of "reserve for
unexpired risks" held by General Insurance Companies. But it is of no
assistance in the present case. In the first place, the provision for taxation
made is very different in nature from the reserve for unexpired risks
referred to in the circular. The reserve in that case represented a sum of H
494 SUPREME COURT REPORTS [1996] 2 S.C.R.
r
<
A money which would be available to the insurance company for payment or
discharge of unexpected claims that may arise in respect of policies which
extend beyond the accounting year. The provision for taxation in the
present case, however, is set apart to meet a specific liability which
would arise at the end of the current accounting year. It cannot, in any
B manner, be compare to a fund of the kind referred to in the circular of the
Board. [501-A-B; E-F]
1.4. The Board has considered the etymological meaning of "fund" in
considering a reserve to meet future unexpired risks. A sum of money set
apart to meet such unforeseen risks was considered as a fund. A provision
C for taxation of the kind in question is not a fund either etymologically or
in accounting parlance. The more relevant meaning of the te~m "fund" in
the context of the two Acts is what that terms is commonly considered to
connote when used in a balance sheet or profit and loss account of a
company. A specific provision for an ascertained liability is not a fund
D within the meaning of that terms in the rules in question. [501-G-Hi 502-A]
Vazir Sultan Tobacco Co.· Ltd. v. Commissioner of Income-Tax, 132
ITR 559 and Duncan Brothers & Co. Ltd. v. Commissioner of Income-Tax,
Central, Calcutta, 128 ITR 302, referred to.
E Dictionary for Accountants, 4th Edition by Eric L. Kohler, pages 204
to 208, referred to.
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 595 of
1978.
F From the Judgment and Order dated 24.12.76 of the Calcutta High
Court in l.T.R. No. 642 of 1972.
S.N. Terdol for the Appellant.
S.N. Gupta for the Respondent.
G
The Judgment of the Court was delivered by
MRS. SUJATA V. MANOHAR, J. This is an appeal from a decision
of the Calcutta High Court in a Reference made to it under Section 256(1)
H of the Income-Tax Act, 1961.
~
,\
C.LT. v. DUNKAN BROS. AND CO. [MRS. SUJATA V. MANOHAR, J.] 495
The assessee is a company and the accounting years involved are the A
years ending on 31.12.1962 and 31.12.1963 relevant to the assessment years
1963-64 and 1964-65 respectively.
For the assessment year 1963-64, the assessee claimed that for the
purposes of Super Profits Tax Act, 1963, in the computation of its capital,
a provision for taxation made by it to the tune of Rs. 16,48,888 should be
B
treated either as a part of its capital under Rule 1 of the Second Schedule
to the Super Profits Act, 1963 or in the alternative as a deduction from the
cost of investment under Clause (ii) of Rule 1 of the Second Schedule to
the Super Profits Tax Act, 1963.
c
For the assessment year 1964-65, the assessee made a similar claim
in respect of a provision for taxation made by it to the tune of Rs. 17,52,920.
For this assessment year the relevant provisions which were applicable
were under the Companies (Profits) Surtax Act, 1964..
The claim of the assessee was disallowed by the Income-Tax Officer.
D
In appeal before the Appellate Assistant Commissioner for the assessment
year 1963-64, the Appellate Assistant Commissioner held that as the
provision for taxation was only an amount set apart to meet the liability for
taxation which would accrue on the last day of the accounting year, it could
not be treated as a reserve and be included in the capital of the assessee E
under the Super Profits Tax Act, 1963. He, however, accepted the alterna-
tive contention of the assessee that the provision for taxation fell within
Clause (ii) of Rule 1 of the Second Schedule to the Super Profits Act, 1963
and it should be deducted from the cost of investments in computing the
capital based of the assessee-company under the Super Profits Tax, 1963. F
For the assessment year 1964-65, the Appellate Assistant Commis-
sioner similarly held that the provision for taxation cannot be considered
as a reserve but it was to be deducted from the cost of investments under
Rule 2(ii) of the Second Schedule to the Companies (Profits) Surtax Act, G
1964.
The matter was taken in appeal before the Tribunal which came to
the conclusion that the provision for taxation made in the two assessment
years was not a reserve which would form a part of the capital of the
company. It further held that the provision for taxation was also neither a H
'(
)
496 SUPREME COURT REPORTS (1996] 2 S.C.R. \
A fund nor a surplus. It was a provision against a "perfected debt" and as
such it would not qualify for a deduction as claimed by the assessee
company.
The Tribunal made a Reference to the High Court under Section
256(1) of the Income Tax Act 1961. The questions of law which arose for
B determination were as follows :
For the assessment Year 1963-64
"(1) Whether, on the facts and in the circumstances of the case,
.c the Appellate Tribunal was right in holding that 'provision for
Taxation' is not a reserve as to form part of the capital under
Rule-1 of the Second Schedule to the Super Profits Tax Act, 1963?
(2) If the answer to the above question is in the affirmative, whether
on the facts and in the circumstances of the case, the Appellate
D Tribunal was right in holding that in the computation of capital
the company was not entitled to the benefit of deduction of the
amount of 'provision for taxation' from its cost of investments in
terms of clause (ii) of Rule - 1 of the Second Schedule to the Super
Profits Tax Act, 1963?"
E
For the Assessment Year 1964-65
w~hether, 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
F
'Provision for Taxation' from its .cost of investments in terms of .
Clause (ii) of Rule -2 of the Second Schedule of the Companies
(Profits) SurtaX Act, 1964?"
The Calcutta High Court has answered Question No. 1 for the
G assessment year 1963-64 in the affirmative in favour of the revenue. It has
a1swered Question No. 2 for the assessment year 1963-64 and .the question
for the assessment year 1964-65 in the negative and in favour of the
assessee. The revenue has come in appeal before us from the above
decision of the Calcutta High Court. The assessee has not filed an appeal
H before us in respect of the decision of the Calcutta High Court on Question
C:I.T. v. DUNKAN BROS. AND CO. [MRS. SUJATA V. MANOHAR, J.] 497
No. 1 for the assessment year 1963-64. A
The only issue before us is whether the provision for taxation can be
deducted from the cost of excluded investments and would, therefore,
augment the capital base of the company for the purposes of the Super
Profits Tax Acts, 1963 and the Companies (Profits) Surtax Act, 1964.
Under both the Act, the tax is levied on the chargeable profits of the
B
company as exceed the standard deduction or the statutory deduction.
Such deduction has to be worked out at the prescribed percentage of the
capital of the assessee company. The computation of capital for the
- purposes of these two Acts has to be made in accordance with the
provisions of the Second Schedule in both these Acts. The Second
Scheduled to the Super Profits Tax Act, 1963 consists of three rules while
C
the second Schedule to the Companies (Profits) Surtax Act, 1964 consists
of four rules~ The relevant rules under both these Acts for our purposes
are as follows :
D
The Super Profits Tax Act, 1963
11te Second Schedule
Rules for computing the capital of a company for the purposes of
Super Profits Tax:
E
"Rule 1: 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, .......................... and
of its other reserves ............... diminished by the amount by which
the cost to it of the assets the income from which in accordance
F
with clause (iii) or clause (vi) or clause (viii) of rule 1 of the First
Schedule is not includible in its chargeable profits, exceeds the
aggregate of --
(i) any money borrowed which remains outstanding; and G
-- (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 this
rule.
······················································ H
.-
'(
J
·'\
498 SUPREME COURT REPORTS [1996) 2 S.C.R.
A The Companies (Profits) Surtax Act, 1964
The Second Schedule
''Rules for computing the capital of a company for the purposes of
swtax:
B 1. Subject to the other provisions contained in this Schedule, the
capital of a company shall be the aggregate of the amounts, as on
the first day of the previous year relevant to the assessment year,
of -
(i) its paid-up share capital;
c
(ii) its reserves ............. .
2. Where a company owns any assets the income from which in
·accordance with clause (iii) or clause (vi) or clause (viii) of rule
1 of the First Schedule is required to be excluded from its total
_D 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 -
E
(i) any moneys borrowed .............................:.
(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....."
F
In the present case, the aSsessee has earned income from dividends
as envisaged in Clause (viii) of Rule 1 of the Second Schedule. The assessee
contends that while the capitaL involved in the investment in shares has
been deducted in. the computation of. its 'Capital the amount of such capital
deducted should reduced by the amount of ".any fllnd, any surplus and any
G reserve" in terms of Clause (ii). of Rule 1 of the Second Schedule of the
Super Profits tax Act, 1963 an.fj the correspondifig Clause of Rule 2(ii) of
the Second Schedule of the Co~panies (Profits) Surtax Act, 1964. It is
contended that the provision made for taxation should be regarded as a
reserve and should thus be included straightaway in the computation of
H capital or otherwise, it should be deducted from the cost of investment in
C.I.T. v. DUNKAN BROS. AND CO. [MRS. SUJATA V. MANOHAR, J.] 499
the shares which are deducted from the computation of capital. Jn view of A
the decision of this Court in Vazir Sultan Tabacco Co. Ltd. v. Commissioner
of Income Tax, (132 ITR 559 at 572), a provision made to meet the tax
liability of the current accounting year cannot be considered as repre-
senting a reserve. We, however, have to consider the alternative submission
that it should be treated as a fund, and, therefore, should be deducted from
B
the cost of the assets required to be excluded from the capital of the
company.
Since the Second Schedule to both these Acts pertains to computing
the capital of a company for the purposes of tax under these Acts, the
terms used in the Second Schedule need to be interpreted in the context C
of the balance sheet of a company and its profit and loss account which
will necessarily have to be looked at to ascertain the company's capital and
its profits. The terms used must, therefore, be read in the ·1ight of the
provisions of the Companies Act and how these terms are understood in
accounting parlance. The form of the balance sheet of a company
prescribed under Schedule VI to the Companies Act, 1956, under the D
column " reserves and surplus" contains a note to the following effect :
"The word 'fund' in relation to any 'Reserve' should be used only
where such Reserve is specifically represented by earmarked in-
vestments.'' E
The juxtaposition of funds with surplus and reserves clearly refers to
accounting language and the manner in which these three terms are
understood in accounting practice. Our attention is also drawn to the term
"fund" as described in the Dictionary for Accountants, 4th Edition by Eric
L. Kohler, pag?s 204 to 208 as set out in the judgment of the Calcutta High F
Court in Duncan Brothers &: Co. Ltd. v. Commissioner of Income-Tax,
Central, Calcutta, 128 ITR 302 at 311 which is as follows :
"Fund. 1. An asset or group of assets within any organization,
separated physically or in the accounts or both from other assets G
and limited to specific uses. Examples : a petty-cash or working
fund; a replacenient-and-renewal fund; an accident fund; a contin-
gent fund; a pension fund.
2. Cash, securities, or other assets placed in the hands of a trustee,
principal or income or both being expended in accordance with H
/\
\
500 SUPREME COURT REPORTS [1996] 2 S.C.R.
A the terms of a formal agreement. Examples: a trust fund created
by a will; an endowment fund; a sinking fund.
3. (government accounting) A self-balancing group of accounts -
asset, liability, revenue and expense - relating to specified sources
and uses of capital and revenue.
B
4. pl. Current assets less current liabilities (on an accrual basis) :
working capital; a term used in flow statements.
5. pl. = cash.
c v.t. 1. To convert currently maturing liabilities into a long-term
loan.
2. To provide for the ~ltimate payment of a liability by the sys-
tematic accumulation of cash or other assets in a separate account
or trust.
D
A special revenue fund is created for taxes and other revenues
levied or set aside for specified purposes. For example, if a
separate tax is authorised for schools, a special revenue fund is set
up to account for its disposition. The accounting principles, pro-
'E cedures, and financial statements of a special- revenue fund
resemble those of the general fond ..... .
Other Funds.
A balance-sheet combining a group of related funds shotJld
F indicate the amount of assets, liabilities, reserves and surplus
applicable to each fund within the group. The revenues and ex-
penditures of each fund must likewise be kept independent, and
the revenues of one fund should not be used to meet the expen-
ditures of another without legal authority or opinion behind the
action."
G
In the present case there is no systematic accumulation of cash or
any separation of assets to meet future tax liabilities. There is .only an
accounting entry of an exact ·sum being earmarked for payment of tax
liability arising at the end of the current accounting year. Such a provision
H cannot be considered as a fond.
C.l.T. v. DUNKAN BROS. AND CO. [MRS. SUJATA V. MANOHAR, J.] 501
The assessee has relied upon a Circular No. 1.P. (XV-5) of 1968 A
dated 23rd of January, 1968, issued by the Central Board of Revenue. The
circular deals with the treatment of an amount standing to the credit of
"reserve for unexpired risks" held by General Insurance Companies. The
circular, inter alia, states as follows :
B
"The Board are advised that, while the 'reserve for unexpired risks'
cannot be regarded as a 'reserve' or 'surplus', it would qualify for
being considered as a 'fund' within the meaning of rule 2(ii) of the
said Second Schedule. The term 'fund', it will be observed, has not
been defined in the Companies (Profits) Surtax Act, 1964. As such,
c
-
it is to be given its ordinary meaning as under stood in common
parlance. Etymologically, 'fund' means a sum of money available
for the payment or discharge of liabilities. As the 'reserve for
unexpired risks' clearly represents a sum of money available to the
company for payment or discharge of unexpected claims that may
arise in respect of policies which extend beyond the relevant D
accounting year, the amount standing to the credit of this account
can be regarded as a fund ........................."
This circular, however, is of no assistance in the present case. In the
first place, the provision for taxation made in the present case is very
different in nature .from the reserve for unexpired risks referred to in the E
circular. The reserve in that case represented a sum of money which would
be available to the insurance company for payment or discharge of unex-
pected claims thai: may arise in respect of policies which extend beyond
the accounting year. The provision for taxation in the present case, how-
ever, is set apart to meet a specific liability which would arise at the end F
of the current accounting year. It cannot, in any manner, be compared to
a fund of the kind referred to in the circular of the Board.
The assessee, however, has submitted that the circular of the Board
has taken the meaning of the term "fund" in its literal or etymological sense. G
Hence it must be applied to any sum of money available to the company
including a provisions for taxation. The argument has no merit. The Board
--- has considered the etymological meaning of."fund" in considering a reserve
to meet future unexpired risks. A sum of money set apart to meet such
unforeseen risks were considered as a fund. We fail to see how the circular
helps. the assessee in the case before us. A provision for taxation of the H
502 SUPREME COURT REPORTS . [1996] 2 S.C.R.
A kind m question is not a fund either etymologically or in accounting
parlance. The more relevant meaning of the term "fund" in the context of
the two Acts is what that term is commonly considered to connote when
used in a balance sheet or profit and loss account of a company. A specific
provision for an ascertained liability is not a fund within the meaning of
B. that term in the rules in question.
In the premises, Question No. 2 for the assessment year 1963-64 and
the question for the assessment year 1964-65 has to be answered in the
affirmative and in favour of the revenue. The appeal is accordingly allowed.
In the circumstances, however, there will be no order as to costs,
c G.N. Appeal allowed.
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