Holding

Excess amounts transferred to the reserve fund beyond the 20% required by Section 17(1) of the Banking Regulation Act are not deductible under clause (xi)(a) of the Companies (Profits) Surtax Act, as no binding RBI direction under Section 35A exists.

Summary

The Andhra Bank Ltd. appealed against the Income Tax Commissioner challenging the disallowance of deductions for amounts transferred to its reserve fund exceeding the statutory 20% of profit. The bank argued that a direction from the Reserve Bank of India under Section 35A compelled it to transfer a larger sum, which should be deductible under clause (xi)(a) of Rule 1 of the First Schedule to the Companies (Profits) Surtax Act, 1964. The Supreme Court held that the exclusion under clause (xi)(a) is limited to the amount required by Section 17(1) of the Banking Regulation Act and that the RBI circulars do not constitute a binding direction under Section 35A. Consequently, any excess transfer beyond the 20% statutory minimum is not eligible for deduction. The Court dismissed the appeals, affirming the High Court’s decision.

Issues considered

Whether sums transferred to a banking company's reserve fund in excess of the 20% profit requirement under Section 17(1) of the Banking Regulation Act qualify for exclusion under clause (xi)(a) of Rule 1 of the First Schedule to the Companies (Profits) Surtax Act, 1964.
Whether a direction issued by the Reserve Bank of India, purportedly under Section 35A of the Banking Regulation Act, can make such excess transfers deductible.
Whether RBI circulars and letters constitute a binding direction under Section 35A.

Legislation cited

Banking Regulation Act, 1949s. Section 17(1), s. Section 18, s. Section 29, s. Section 35A
Companies Act, 1956
Companies (Profits) Surtax Act, 1964s. clause (xi)(a), s. Rule 1 of First Schedule
Income Tax Act, 1961

Subjects

chargeable profitsreserve fundSection 17Banking Regulation ActCompanies (Profits) Surtax Actexclusion clauseReserve Bank of IndiaSection 35Atax deductionbanking company

Judgment

M/S. THE ANDHRA BANK LTD., HYDERABAD A
V,

THE COMMISSIONER OF INCOME TAX, AP. lll, HYDERABAD

SEPTEMBER 22, 1995

[AM. AHMADI, CJ, S.C. SEN AND KS. PARIPOORNAN, .LL[ B

> Companies (Proji1s) Swtax Act, 1964/Banking Regulalion Act, 1949:

Ss.2(5), First Sched11/e R11/e 1 cla11se (xi)/Section 17-Swtax assess-
mcnt.1---<:hargeab/e profit.1-20'70 Profit to be tra11.1fC1red to the rese1ve fund C
as per S. 17( J) of' Banking Rci,"J/ation and q11alifies j(H exclusion-Any s11111
more than the specified 21!'7'r-Held: Would not qua/if)' for exclusion.

The dispute raised in these appeals by the appellant-Bank relates to
the computation of 'chargeable profits'.
D
It was contended by the appellant-assessee that a reserve fund was
created by the assessee bank to comply with the provisions of S.17 of the
Banking Regulation Act; that though the amount of contribution was
higher than 20% of its balance of profits, the entire amount would have to
be deducted from its total income in order to arrive at chargeable profit E
under clause (xi) of Rule 1 of the First Schedule to the Companies
(Profits) Surtax Act because the amount in excess of t_he statutory mini-
mum was contributed pursuant to the direction given by the Reserve Bank
of India, which is binding on the appellant.

Dismissing the appeals, this Court F

HELD : L Assuming that the assessee bank was under a legal obliga-
tion to transfer a sum in excess of 20o/c hy virtue of a direction given by the
Reserve Bank of India, then the excess contribution to the reserve fund was
not because of any requirement of Section 17 but because of the provisions G
of some other Section. The exclusion permissible under clause (xi) of Rule
1 of the First schedule to the Companies (Profits) Surtax Act, 1964 is
limited only to the sum "not exceeding the amount required under the
aforesaid provisions to be so transferred ..... ". The 'aforesaid provisions' in
this clause means the provisions of Section 17(1) of the Banking Regula-
tions Act. If any further sum is transferred to the reserve fund by virtue of H
41
42 SUPREME COURT REPORTS [1995] SUPP. 4S.C.R.

A provisions of some other sections of the Act, such sum will not qualify for
exclusion in computation of chargeable profits. [45-G-H, 46-A]

2. Fro1n the various circulars relied upon by the assessee Bank, it does
not appear that the Reserve Bank of India gave any direction under Section
35A of the Banking Regulation Act to transfer more than 20% to the reserve
B fund. A circular letter dated 27.12.1961 was issued h_y the (:Jovernor, Resen'e
Bank ofJndia, to all the scheduled Banks. However, this cannot be construed
as a direction by the Reserve Bank of India under Section 35A. Similarly, the
circular letter WTitten on 25th January, 1962 deals with 'a point which has
been raised by the Bank'. This letter is in the nature of advice and contains
direction as to Jun\' profit should be calculated before transfer of the requisi-
c te 20o/o is made to the reserve fund. Banks having resenres et1ual to or in
excess of their paid-up capital should transfer 20% of profits after making
the usual provisions and after deduction of provisions for taxation. But
those Banks whose reserves are not equal to their paid-up capital should
transfer 20% of their profits before tax to the reserve fund till the parity of
D paid-up capital is reached. [46-B, D, H, 47-A]

3. None of the circular-letters sent by the Reserve Bank of India to
the Banks nor the letters written specifically to the assessee Bank go to
show· that the Reserve Bank of India had directed the Banks or the
assessee-bank to transfer a larger amount than what was re11uired by
E Section 17(1) of the Banking Regulation Act. Therefore, it cannot be said
that. the assessee had been directed by the Reserve Bank of India under
Section 35A to contribute a large amount to the reserve fund than what
was required by Section 17(1) of the Banking Regulation Act. (47-E]

CIVIL APPELLATE .JURISDICTION : Civil Appeals Nos. 4895-96
F
of 1984 Etc.

From the Judgment and Order dated 22.2.84 of the Andhra Pradesh
High Court in Case Referred No. 117 of 1978.

G T.A. Ramachandran and Ms. Janki Ramachandran for the Appel-
lant.

K.N. Shukla, S.N. Terdol, B.S. Ahuja and B.V.B Das, for the
Respondent.

H The Judgment of the Court was delivered by
..,
ANDHRABANKLTD. v. C.l.T. [SEN.].] 43

SEN, J. These arc appeals from a judgment of the Andhra Pradesh A
High Court which answered the following question of law in the affirmative
and against the assessee :

"Whether on the facts and in the circumstances of the case, the
sums of Rs. 4, 12, 700 and Rs. 5,50,000 are liable to be excluded
under Rule l(xi)(a) of the Surtax Rules in computing the charge- B
able profits in Surtax assessments for the assessment years 1971-72
.~
and 1972-73."

The assessment years involved in this case arc 1971-72 and 1972- 73
for which the relevant previous years were calendar years 1970 and 1971 C
respectively. ·

The disputes in this case is about computation of chargeable profits
of a banking company. 'Chargeable Profits' has been defined in sub-section
(5) of Section 2 of The Companies (Profits) Surtax Act, 1964 (for short
'the Act') to mean "the total income of an assessee computed under the D
Income Tax Act, 1961 for any previous year or years, ........... and adjusted
-<f in accordance with the provisions of the First Schedule. 11

There is a specific rule in the First Schedule of the Act relating to
computation of chargeable profits of a banking company which is as under: E

"In computing the chargeable profits of a previous year, the total
income computed for that year under the Income- tax Act shall be
adjusted as follows :

1. Income, profits and gains and other sums falling within the F
following clauses shall be excluded from such total income, namely:

x x x x x x x x

(xi) in the case of a banking company -
G
(a) any sum which during the previous year is transferred by
it to a reserve fund under sub-section (1) of section 17 of the
banking Companies Act, 1949 ....... , not exceeding the amount
required under the aforesaid provisions to be so transferred
or deposited, as the case may be, 0[ 11 H
44 SUPREME COURT REPORTS [1995] SUPP. 4 S.C.R.

A The language of clause (xi) (a) is clear. Whatever amount is
deposited in the reserve fund created under Section 17 (l) of the Banking
Regulation Act will not qualify for deduction. The deduction will be limited
only to the amount which is required to be transferred to the reserve fund
by sub-section (1) of Section 17 of the Banking Regulation Act, 1949.
Sub-clause (a) of clause (xi) clearly stales that when an amount is trans-
B
ferred to the statutory reserve fund, deduction will be limited lo a sum 'not
exceeding the amount required under the aforesaid provisions to be so
transferred'. The legislative in1ent is not to allow the entire sum transferred
to the reserve fund as deduction but to limit it to the amount which is
actually required by the provisions of Section 17(1) of the Banking Regula-
c tion Act to be transferred to the reserve fund.

Section 17 of the Banking Regulation Act, 1949 makes it necessary
for a banking company to create a reserve fund and transfer not less than
20% of its profits to that reserve fund.

D "17. Reserve Fund - (l) Every banking company incorporated in
India shall create a reserve fund and shall, out of the balance of
profit of each year as disclosed in the profit and loss account
prepared under Section 29 and before any dividend is declared,
transfer to the reserve fund a sum equivalent to not less than twenty
E per cent such profit."

The mandate of Section 17 is that every banking company will have
to transfer to a reserve fund every year, a sum equivalent to 11 not less than
twenty per cent of such profit". In other words, at least 20% of the profit
as shown in the Profit and Loss Account before declaration of any dividend
F has lo be transferred to the reserve fund. This is the statutory requirement.
If a banking company transfers any amount in excess of 20% of its profit
of any year to this reserve fund, the exclusion in clause (xi) (a) will be
limited to 20% of the profit which is the requirement to Section 17 (1) of
the Banking Regulation Act.

G Mr. Ramachandran on behalf of the asscssee has contended that in
this case, a reserve fund was created by the assessee bank to comply with
the provisions of Section 17 of the Banking Regulation Act. Even though
the amount of contribution for the relevant accounting period was higher
than 20% of its balance of profits, the entire amount will have to be
H deducted from its total income in order to arrive at chargeable profit under
ANDHRABANKL"ID. v. C.LT. [SEN.J.] 45

clause (xi) of Rule 1 of the First Schedule to the Act, because the amount A
in excess of the statutory minimum was contributed pursueinl to the direc-
tion given by the Reserve Bank of India. Any direction given by the Reserve
Bank of India under Section 35A of the Banking Regulation Act is binding
on a banking company. Therefore, the Bank was under a legal obligation
to transfer more than 20% of its profits to the reserve fund. Since this
B
transfer was made pursuant to direction given by Lhe Reserve Bank of
India, the entire amount so transferred must be allowed as deduction for
computation of chargeable profit.

We are unable to uphold this argument for several reasons. In Lhe
first place, clause (xi) of Rule 1 of the First Schedule to the Acl specifically C
restricts the allowable amount to a sum not exceeding the amount required
under the provisions of Section 17 to be so transferred. Any other sum
transferred to a reserve fund under the direction of Reserve Bank or any
other law will not qualify for deduction. For example, under the Banking
Regulation Act, a bank has to maintain a cash reserve under Section 18 of D
the Banking Regulation Act. Any sum transferred to this reserve will nol
be eligible for deduction from total income computed under the Income
Tax Act. Only the amount transferred to the reserve fund created under
Section 17 will be eligible for deduction and the quantum of deduction is
restricted to the amount required under the provisions of Section 17 of the
Banking Regulation Act to be transferred. Section 17 lays down that before E
any dividend is declared, out of the balance of profit of each year as
disclosed in the profit and loss account, a sum not less than 20% of such
profit will have Lo be transferred to the reserve fund. Deduction under
clause (xi) has been specifically limited to this amount which is required
by Section 17 to be transferred Lo the reserve fund. Tht: phrase 'not F
__, ....
_
exceeding the amount required ......... to be so transferred' indicates that any
other sum in excess of the requirement of Section 17 will nol be eligible
for deduction.

Assuming that the assessce bank was under a legal obligation to G
transfer a sun1 in excess of 20% hy virtue of a direction given by the
Reserve Bank of India 1 then the excess contribution to the reserve fund
was nol because of any requirement of Section 17 but because of Lhe
provisions of some other Section. The exclusion permissible under clause
(xi) of Rule I of Lhc First Schedule of the Act is limited only to the sum
"not exceeding the an1ount required under the aforesaid provisions to be H
46 SUPREME COURT REPORTS [1995] SUPP. 4 S.C.R.

A so transferred ....... 11 • The 'aforesaid provisions) in this clause means the
provisions of Section 17(1) of the Banking Regulation Act. If any further
sum is transferred to the reserve fund by virtue of provisions of some other
sections of the Act, such sum will not quality for exclusion in computation
of chargeable profits.

B Moreover, from the various circulars relied upon by the assessee
Bank, it does not appear that the Reserve Bank of India gave any direction
under Section 35A to transfer more than 20% to the reserve fund. A
circular letter dated 27.12.1961 was issued by the Governor, Reserve Bank
of India, to all the schedl!:· J Banks in which it was stated :-
c "I am aware that several banks obliged to transfer 20 per cent of·
their declared profits in terms of section 17, actually transfer a
quantum larger than that, I have no doubt such banks will continue
to maintain this practice. 11

D This cannot be construed as a direction by the Reserve Bank of India under
Section 35A. Similarly, the circular letter written on 25th January, 1962
deals with 'a point which has been raised by the Bank'. In reply the
Executive Director of the Reserve Bank of India stated :
11
In this connection, \Ve advise as under :
E
2. Certain banks have already reserves which are equal to or exceed
their paid up capital. The intention is that such banks should
transfer not less than twenty per cent of their disclosed profits
arrived at after making the usual and necessary provisions and after
deduction of the provision for taxation.
F
3. There arc several banks the reserves of which are not equal to
their paid-up capital. The intent of the Governor's letter is that
such banks should, till they reach parity of paid- up capital and
reserves, follow the san1e basis of computation as they observed in
their profit and loss account for 1960. That is to say, if they
G
compute transfers to reserves on profits before lax they should
continue to do so till parity is reached."

This letter is in the nature of advice and contains direction as to how profit
should be calculated before transfer of the requisite 20% is made to the
H reserve fund. Banks having reserves equal to or in excess of their said-up
ANDHRABANKLTD. v. C.l.T. [SEN,J.] 47

capital should transfer 20% of the profits after making the usual provisions A
and after deduction of provisions for taxation. But those Banks whose
reserves are not equal to their paid-up capital should transfer 20% of their
profits before tax lo the reserve fund till the parity of paid-up capital is
reached. This circular letter was written by the Executive Director of the
Reserve Bank of India.
B
Reliance has been placed upon two other letters written by the
Reserve Bank of India to the assessee Bank. The first letter is dated 29th
March, 1971 in which the Bank's practice of effecting transfer to the
statutory reserve, after .making provisions for Income Tax, has been com-
mented upon. In this letter, the Deputy Chief Officer of the Reserve Bank C
has made it clear that 'in future, the bank should transfer to the above
reserves a sum not less than 20% of its profits before providing for income
tax. We may add that our approval does not affect in any way the obligation
imposed on your bank by or under any other provisions of the Banking
Regulation Act, 1949 or of the Companies Act, 1956 or any other law for D
the time being in force.'

The other letter dated 23.5.1972 is also in the same vein.

None of these circular-letters sent by the Reserve Bank of India nor
the letters written specifically to the assessee-Bank go to show that the
Reserve Bank of India had directed the Banks or the assessee-bank to E
transfer a larger amount than what was required by Section 17(1) of the
Banking Regulation Act. Therefore, the argument that the assessee had
been directed by the Reserve Bank of India under Section 35A to con-
tribute a larger amount to the reserve fund than what was required by
Section 17(1) is misconceived. F
In view of the aforesaid, we hold that the question referred to the
High Court was· correctly answered by it. These appeals are dismissed.
There will be no order as to costs.

Civil Appeal No. 861 of 1988. G
In view of our judgment in Civil Appeals Nos. 4895-96 of 1984, this
appeal is also dismissed.

G.N. Appeals dismissed.