Holding

The amount is a provision, not a reserve, and therefore is excluded from the computation of capital.

Summary

Karamchand Premchand Pvt. Ltd. set aside Rs 4,50,000 as a provision for a possible tax liability under Section 23A of the Income‑Tax Act, 1922. The company later claimed that this amount was a reserve and should be included in its capital for the purposes of Rule 1 of the Second Schedule of the Super Profits Tax Act, 1963. The Income‑Tax Officer disagreed, and the matter went to the Income Tax Appellate Tribunal, which at one point held it a reserve for a later assessment year but not for the year in question. The Revenue referred the question to the Gujarat High Court, which held the amount to be a provision, not a reserve. On appeal, the Supreme Court affirmed that a provision is a charge against profits, whereas a reserve is an appropriation of profits forming part of capital, and therefore the Rs 4,50,000 is a provision and must not be included in the computation of capital. The appeal was dismissed.

Issues considered

Whether the amount of Rs 4,50,000 set apart for a contingent tax liability under Section 23A is a provision or a reserve for the purpose of computing capital under Rule 1 of the Second Schedule of the Super Profits Tax Act, 1963.

Legislation cited

Companies Act, 1956
Income Tax Acts. 256(1)
Income Tax Act, 1922s. 23A
Super Profits Tax Act, 1963s. Second Schedule Rule I

Subjects

Super Profits TaxProvisionReserveContingent liabilityCapital computationIncome Tax ActSection 23ARule 1 Second ScheduleSupreme Court

Judgment

KARAMCHAND PREMCHAND PVT. LTD. A
v.
COMMISSIONER OF INCOME TAX, GUJARAT

FEBRUARY 25, 1993

B
(B.P. JEEVAN REDDY AND N. VENKATACHALA, JJ.)

Super Profits Tax Act, 1963 :

Second Schedule-Rule I-Amount set apart for contingent liability
(Income-tax}-Whether a reserve or a provision-Whether to be included in C
the Computation of Capital of the assessee.

The appellant-assessee was issued a notice under Section 23A of the
Income-tax Act, 1922. The '\Ssessee contested the same. At the same time,
it set apart a sum of Rs. 6,52,000 in its books for the year ending 31st D
March 1956, to meet the contingency that may arise if bis plea failed.
During the year 1958-59 an amount of Rs. 2,02,000 out of the said amount
was transferred to the profit & loss account. The balance amount of Rs.
4,50,000 continuer) to remain and was shown as a provision set apart to
meet the aforesaid contingent liability. The assessee bas been contesting
the said proceedings. Ultimately it succeeded before the High Court which E
held that no action could be taken against the assessee under Section 23A.

For the assessment year 1963-64 in proceedings under the Super
Profits Tax Act, the assessee claimed that the said sum of Rs. 4,50,000 was
F
- a reserve and should be included in its capital. The Income tax Officer did
not agree. Ultimately the matter reached the Tribunal which agreed with
the assessee. At the instance of Revenue the question as to whether the
snm of Rs. 4,50,000 set apart for contingent liability (taxation) was to be
included in the computation of capital of the assessee-company under Rule
1 of the Second Schedule of the Super Profits Tax Act, 1963 was referred G
to the High Court.

The High Court having answered the question against the assessee,
th. assessee bas preferred the present appeal contending that inasmuch
-"-, as no order levying additional tax under Sec. 23A was made the amount
could not be treated as a provision. H
109
110 SUPREME COURT REPORTS (1993] 2 S.C.R.

A Dismissing the appeals, this Court,

HELD : 1.1. Provisions made against anticipated losses and contin-
gencies are charges against profits and, therefore, to be taken into account
against gross receipts in the P.&L. accounts and the balance-sheet. On the
other band, reserves are appropriations of profits, the assets by which they
B are represented being retained to form part of the capital employed in the
business. [112G]

1.2. In the instant case, the provision made by the assessee in its
Books for meeting the anticipated liability of tax (under Section 23A of the
C Income Tax Act, 1922) was indeed a provision and not a reserve. The
assessee itself called it a provision. It did not call it a reserve nor was the
amount set apart or appropriated as a reserve. It is not to snggest that
the description given or the Book entries made by the assessee are con-
clusive, but to emphazise how the assessee understood the said item itself.
In the circumstances of the case the High Court was right in holding it to
D be a provision and not a reserve, and so the amount of Rs. 4,50,000 was
not to be included in the computation of Capital of the assessee Company.
[113E]
Metal Box Compa11y of India Limited v. Their Worl<men, 73 I.T.R. 53
and Vazir Sulta11 Tobacco Co.• Ltd. etc. etc. v. Commissio11er of /11come Tax,
E Andhra pradesh etc. etc., 132 I.T.R. 559, relied on.
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 2230 (NT)
of 1977.

From the Judgment and Order dated 13.12.76 of the Gujarat High
F Court in Income Tax Reference No. 36 of 1972. -
Mrs. A.K. Verma, for JBD & Co. for the Appellant.

G.C. Shar.ma, E.U.Eradi and T.R. Talwar for the Respondent.

G The. Judgment of the Court was delivered by

B.P. JEEVAN REDDY, J. This appeal is preferred by the assessee
against the judgment of the Gujarat High Court answering the question,
referred at the instance of Revenue, against the assessee. The following
question was referred under Section 256{1) of the Income Tax Act for the
H opinion of the High Court:
KARAMCHAND PREMCHAND v. C.l.T. [JEEVAN REDDY, J.] 111

"Whether on the facts and in the circumstances of the ease, A
the following amounts are to be included in the computa-
tion of capital of the assessee Company under Rule 1 of
the Second Schedule of the Super Profits Tax Act, 1963:-

(i) Amount set apart for contingent Rs. 4,50,000 B
liability (taxation)
(ii) Amount set apart for proposed divi- Rs. 19,90,000
dend
(iii) Reserve for Depreciation fund in ex- Rs. 6,77,122
cess of the amount allowed as depre-
ciated in income-tax c
(iv) Excess provision in Revenue Acco- Rs. 3,61,876
unts disallowed in income-tax assess-
men! for the assessment years."

Though the question refers to four items, we are concerned in this D
appeal only with the first item. We shall, therefore, state the facts only in
so far as they are relevant to the said item.

The assessee is a Private Limited Company. The assessment year
concerned is 1963-64. Sometime in 1955-56, a notice was issued to the E
assessee under Section 23A of the Income Tax Act, 1922. Apprehending
that it may become liable to pay additional tax under the said provision,
the assessee set apart a sum of Rs. 6,52,000 in its Books for the year ending
March 31, 1956. Out of this amount an amount of Rs. 2,02,000 was
transferred to the profit and loss account during the year 1958-59, with the
result tha\ a sum of Rs. 4,50,000 continued to remain and was shown as a F
provision set apart to meet the taxation liability which the assessee called
a cot¥ingent liability. At the same time the assessee had been contesting
the proceedings taken against it under Section 23A. Though it failed at the
earlier stages, it succeeded ultimately in the Letters Patent Appeal filed by
it in the East Punjab High Court. In the said appeal decided on May 24, G
1965, it was held that no action can be taken against the assessee under
Section 23A. With this order, all the orders passed and notices issued
under the said provision prior to the date of t~e said judgment stood
vacated.

In its assessment relating to the assessment year 1963-64 under the H
·.;,'

112 SUPREME COURT REPORTS (1993] 2 S.C.R.

A Super Profits Tax Act, the assessee contended that the said sum of Rs.
4,50,000 is a reserve and should be included in its capital for the purposes
of the Act. The Income Tax Officer did not agree and the matter was
ultimately taken to the 'ncome Tax Appellate Tribunal. By the date this
appeal was taken up for hearing, another appeal preferred by the assessee
relating to the subsequent assessment year (1964-65) was also before the
B Tribunal. That appeal arose under the provisions of the Companies Sur-tax
Profits Act, 1964 which replaced the Super Profits Tax Act. The Tribunal
first disposed of the appeal relating to the. assessment year 1964-65. In so
far as the item in question is concerned it held that it was a reserve.
Following the said judgment, the appeal pertaining to the assessment year
c 1963-64 was also allowed. (It may be stated that the order of the Tribunal
relating to assessment year 1964-65 was subsequently rectified by an order
dated February 15, 1972 and the said item was held to be a provision. Bu!
no such order was passed with respect to the assessment year 1963-64).

D Aggrieved by the judgment of the Tribunal the Revenue obtained the
aforesaid reference. The High Court answered the same. in favour of
Revenue and against the assessee following the decision of this Court in
Metal Box Company of India Limited v. Their Workmen, 73 l.T.R. 53. It
held that the said amount being a provision made towards a liability which
had attached on account of the issuance of a notice was a provision and
E not a reserve. In this appeal the correctness of the said view is questioned.
The learned counsel for the appellant-asscssee submitted that inasmuch as
no order levying additional tax under Section 23A was made on or before
the date relevant to the assessment year 1963-64 the said amount cannot
be treated as a provision. We find it difficult to agree. In Metal Box, which
has been followed in Vazir Sultan Tobacco Co. Ltd. etc. etc. v. Commissioner
F
of Income Tax, Andhra Pradesh etc. etc., 132 l.T.R. 559, the distinction
between provision and reserve is stated in the following words:

"The distinction between a provision and a reserve is
in commercial accountancy fairly well known. Provisions
G made against anticipated losses and contingencies are
charges against profits and, therefore, to be taken into
account against gross receipts in the P. & L. accounts and
the balance-sheei. On the other hand, reserves are ap-
propriations of profits, the assets by which they are rep-
H resented being retained to form part of the capital
KARAMCHAND PREMCHAND v. C.I.T. [JEEVAN REDDY, J.J 113

employed in the business. Provisions are usually shown in A
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 Ac-
counts, 15th Edn. p. 42)."
B
While approving the said statement it was stated in Vazir
Sultan:

"In other words the broad distinction between the two
is that whereas a provision is a charge against the profits
to be taken into account against gross receipts in the c
P.&L. account, a reserve is in appropriation of profits, the
asset or assets by which it is represented being retained
to form part of the capital employed in the business.
Bearing in mind the aforesaid broad distinction we will
briefly indicate how the two concepts are defined and D
dealt with by the Companies Act, 1956."

Applying the said test it must be held that the provision made by the
assessee in its Books for meeting the anticipated liability of tax (under
Section 23A) was indeed a provision and not a reserve. The assessee itself
called it a provision. It did not call it a reserve nor was it set apart or E
appropriated as a reserve. We are not suggesting that the description given
or the Book entries made by the assessee are conclusive. We are only

- emphasizing how the assessee understood the said item itself. In the
circumstances of the case we must hold that the High Court was right in
holding it to be a provision and not a reserve. F
The appeal accordingly fails and is dismissed. No costs.

G.N. Appeals dismissed.

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