Civil Appeal No 1599 of 1974 400 From the Judgment and Order dated 1971973 of the Allahabad High Court in IT Reference No 200 of 1971
and Civil Appeal No 1546 of 1974 From the Judgment and Order dated 2171972 of the Allahabad High Court in IT Reference No 172 of 1971
SLP No 4815A of with 1977 BB Ahuja for the Appellant in CA No 1599 of 1974
Dalip Singh Ms A Subhashini and KC Dua for the Appellant in CA No 1546 of 1974 and SLP No 4815A of 1977
Harish Salve KJ John Ranjit Kumar and BP Singh for the Respondents
The Judgment of the Court was delivered by SABYASACHI MUKHARJI J
In Civil Appeal No 1546 of 1974 the following items were involved a Capital Reserve b Stocks and stores reserves c Bad and doubtful debts reserves d Obsolescence reserve e Loans and Insurance reserve f Investment reserve and g Forfeited moneys reserves
The question was whether these were to be included in the computation of capital according to the provisions in the second schedule to the 
Under Section 4 of the  every company shall be charged for every assessment year commencing from 1st April 1963 a tax as Super Profits tax in respect of so much of its chargeable profit of the previous year as exceed the standard deductions at the rate or rates specified in the third schedule Standard deduction  had been defined in clause 9 of section 2 as follows An amount equal to six per cent of the capital of the company as computed in accordance with the provisions of the second schedule on an amount of Rs50000 whichever is greater
 The second schedule contained rules for computation of capital of a company for the purpose of the said Act
401 None of the reserves claimed by the assessee had been allowed as deductions in the computation of its profits under the relevant Income tax Act
The question was whether these represented reserves
The Tribunal has referred to this Court the following question Whether on the facts and in the circumstances of the case the Tribunal was right in holding that a Capital Reserve b Stocks and stores reserves c Bad and Doubtful debts reserve d Obsolescence reserve e Loans and Insurance reserves f Investment reserve and g Forteited moneys reserves were to be included in the computation of capital according to the provisions in the second schedule to the  We must observe that so far as the capital reserves are concerned in view of the findings recorded by the High Court that the amount represented reserve and it was not ear marked for any existing liability for being utilised by the company it must be held to be reserve
The capital reserve which was a sum of Rs 1173952 consisted of two amounts namely Rs12212 and Rs1161770
The amount of Rs12212 represented an insurance claim received by the assessee company on account of a fire which had destroyed some assets of the assessee company
The said receipt of fire insurance claim has directly been credited to the capital account and the sum of Rs1161770 was credited by transfer from the Profit  Loss Account in the earlier years
This was not provided for against any existing or future liability
It was rightly treated as capital reserve
The next item was Stocks and Stores Reserve
This was created in 1950 by transfer from the Profit and Loss Appropriation Account
This did not represent any existing provision for existing liability to meet any specific contingency for safeguarding against diminution of the value of the stocks and stores
It was in the nature of a reserve for safeguarding against any possible diminution of the value of stocks and stores on any future occasion
In our opinion the Tribunal was right in treating it as reserve
Bad and Doubtful Debts Reserve was created in 1956 through the Profit and Loss Appropriation Account
The amount involved was 402 Rs500000
It was submitted on behalf of the assessee by Shri Salve that this was created by transfer from the Appropriation Account and not a charge against profit
Furthermore a separate provision was made for bad and doubtful debts which provision was reduced from the value of the assets
It was not the revenue s case that the provision for bad and doubtful debts provided was less than the amount reasonably necessary to be provided
If the amount as it appears to be is more than the amount reasonably necessary to be provided in respect of bad and doubtful debts then it constituted a reserve 
It is not correct to state that by very nomenclature this was not a reserve
True nature of the transaction has to be examined
The next item is Obsolescence Reserve of Rs172259
This was created in 1959 by transferring a sum of Rs1205000 from the Profit and Loss Account
Some amounts were written off out of this reserve in 1960 and 1961
This appears to be provision to meet future liability and contingency
But there are not much facts about it
Had it been necessary we might have remanded the matter to the High Court to direct the Tribunal to find facts on this aspect
But as in that view of the matter this item was not pressed before us so this item is deleted from reserve of the assessee
So far as Loan and Insurance Reserve is concerned this was created prior to 1947
It was found that it was free from any burden and it was not utilised for any purpose and was transferred to the General Reserve Account in 1963
Therefore it was rightly treated in view of the principles mentioned hereinbefore as reserve
The next item is Investment Reserve
This fund was created out of the surplus on the sale of investment which was not held by the respondent company as its stock in trade
The surplus did not have its origin in business profits and was transferred directly to the reserve account but this was created prior to 1954 and was further credited in 1955 to 1957 out of the profits on sale of investments
In the later years whenever a loss of a capital nature was incurred it was debited to this account
It appears that at the time of creating this Reserve the Directors could not have possibly anticipated the losses which might occur in future but merely created a reserve so that losses which do normally arise in the course of business might be adjusted against this amount
It appears therefore that this was a reserve created out of the capital profit
This reserve can rightly be treated as other reserves
Forfeited moneys reserve in our opinion cannot be treated as 403 reserve and the High Court has also not treated it as such
In that view of the matter except the item indicated as Obsolescence Reserve which is deleted from the reserve as indicated before we uphold the order of the High Court
This appeal is dismissed subject to the extent indicated above
There will be no order as to costs
In Civil Appeal No 1599 of 1974 the following facts were recorded The assessee is a limited company
In proceedings under the Super Profit Tax Act 1963 the assessee claimed that the following amounts appearing as credit balances in the various accounts mentioned against each be treated as reserves and included in the capital of the company for the purposes of determining the standard deductions as contemplated under section 29 of the Act a Capital reserve Rs941488 b Rehabilitation reserve Rs600000 c Stores reserve Rs 75000 d Forfeited moneys reserve Rs 8000 e Bad and doubtful debts reserve Rs 25000 The Income tax Officer rejected the assessee s claim
On appeal the Appellate Assistant Commissioner allowed the claim of the assessee in part
The revenue and the assessee both went up in appeal before the Tribunal
The Tribunal had allowed the claim of the assessee in full
The revenue feeling aggrieved referred the following question to the High Court Whether on the facts and in the circumstances of the case the Tribunal was right in holding that a Capital reserve b Rehabilitation reserve c Stores Reserve d Forfeited moneys reserve and e Bad and doubtful debts reserve 404 were to be included in computation of capital according to the provisions of the second Schedule to the Supper Profits Tax Act Surtax 1963
 So far as the capital reserve is concerned in the light of discussion in Civil Appeal No 1665 of 1974 CIT Kanpur vs The Elgin Mills Ltd Kanpur Infra p 408 and also in Civil Appeal No 1546 of 1974 CIT Kanpur vs Ms British India Corporation Ltd the High Court was right in treating this account as reserve
It must be further noted that so far as capital reserve was concerned the Appellate Commissioner had allowed a sum of Rs719488 out of a claim of Rs941488
In appeal the Tribunal upheld the order of the Appellate Commissioner
The assessee did not seek a reference against this in the High Court
The controversy before the High Court was confined to the claim allowed by the Appellate Commissioner
The High Court held in favour of the assessee in treating it a reserve
The High Court was right
So far as the rehabilitation reserve and stores reserve are concerned in view of the facts found by the Tribunal and in the light of the reasons indicated in Civil Appeal No 1546 of 1974 in our opinion this must be treated as reserve as was held by the Tribunal
The High Court has disallowed the forfeited money reserve to be treated as reserve
We are of the opinion that the High Court was right
So far as Bad and Doubtful Debts are concerned in the light of the observations made in Civil Appeal No 1546 of 1974 and in the light of the facts found this must be treated as reserve
In the aforesaid view of the matter the appeal fails and is accordingly dismissed
In the facts and circumstances of the case there is no order as to costs
Special Leave Petition No 4815A of 1977 arises out of the decision of the Bombay High Court where the High Court rejected the application under section 2562 of the Income tax Act 1961 for an order directing the Income tax Appellate Tribunal Bombay to state a case in relation to the various items specified in the question
The question was as follows Whether on the facts and in the circumstances of the 405 case the Tribunal was right in holding that Gratuity A Reserve of Rs200000 Reserve for Special Survey of Rs1304600 Reserve for Contingencies of Rs5600000
Fleet Replacement Reserve of Rs5435250 Reserve for exempted profits under section 84 of Rs164900 Reserve for Investment depreciation of Rs709144 and Dividend Equalisation Reserve of Rs200000 were reserves with the meaning of the Second Schedule to the Act The Tribunal by its order dated 21st July 1976 rejected this application as one of fact and the principles not being in dispute
The revenue thereafter applied to the High Court under section 2562 of the Act read with section 18 of the 
By its order dated 20th June 1977 the Bombay High Court allowed the application only in relation to the Reserve for Special Survey for Rs1304600 and rejected the application so far as other items are concerned
Being aggrieved the assessee has come in Special Leave Petition
The facts regarding the same as found by the Tribunal are as follows i The Gratuity Reserve of Rs200000 was created for the first time during the preceding year
The amount was not claimed as revenue expenditure
Some payments were actually paid during the preceding accounting year
The amount was to be included in the capital base as other Reserves
ii Reserve for Special Survey Rs1304600 The balance in this reserve account on the first day of the preceding accounting year was Rs932500 to which was added Rs15 lakhs by transfer from the Profits and Loss Account making a total of Rs2432500
During that preceding year expenses of Rs1126900 were incurred and debited to this reserve and the balance of Rs1304600 was carried forward
This amount was to be included in the capital base
iii Reserve for contingencies Rs5600000 This reserve account was meant to be utilised in case of contingencies and there was no specific liability for spending even a of this amount on the first day of the accounting year and it was therefore includible in the capital base
iv Fleet replacement reserve Rs5435250 This reserve was like the reserve for contingencies
Here also there was no liability in presenti towards purchase of any vessel on the first day of the accounting year and this sum also was includible in the capital base
v Reserve for exempted profits under section 84 of the Income tax Act Rs164900 This was not meant for meeting any liability and had therefore to be included in the capital base
vi Reserve for investment depreciation Rs709144 This reserve was created originally in order to cushion the effect of fluctuations in the prices of foreign securities held by the assessee
This amount was ultimately transferred in 1971 to the Profits and Loss Appropriation Account
Here also the reserve was not created by way of making provision for liability already accrued on or before the first day of the accounting year and had therefore to be included in the capital base
vii Dividend Equalisation Reserve Rs200000 This reserve was set apart to enable the assessee to declare reason able dividend in a year in which the profit was likely to go down
This amount was subsequently transferred to the General Reserve in 1971
This amount was also to be included in the capital base
 In view of the facts as recorded by the Tribunal and in the light of the principles settled by various decisions and reiterated by this Court in Civil Appeal No 1665 of 1974 supra it is not necessary to call for any statement of the case and the High Court was right
It may be mentioned that where the liability has actually arisen or anticipated legitimately by the assessee though the quantum of the liability has not been determined to meet such present liability cannot be treated as reserve 
A fund however created for payment of a liability which had not already arisen or fallen due but only a provision with regard to the sum that might become liable to be paid is other reserve within the meaning of rule 1 of second schedule and should be taken into ac 407 count in computing the capital of the company for the purpose of the Companies Profit Surtax Act 1964
In that view of the matter we are of the opinion that the decision of the High Court was right
The principles applicable in these types of cases have been discussed by this Court in several decisions
It is not necessary to reiterate these again
In the premises this application fails and is accordingly dismissed
In the facts of this case parties will pay and bear their own costs
SR Appeals allowed in part


Summary:
The assessee in CA 1546 of 1974 Ms British India Corporation Ltd claimed capital Reserve Stocks and Stores Reserves Bad and doubtful debts Reserves Obsolescence reserve Loans and Insurance reserve investment reserve and forfeited moneys reserves as standard deduction as defined in section 2a of the in the computation of its profits under the relevant Income Tax Act
The claim having been disallowed the question has been referred to this Court by the Tribunal
In Civil Appeal No 159974 the Saran Engineering Company Ltd claimed similar deductions in respect of capital reserve Rehabilitation Reserve Stores Reserve forfeited moneys Reserve and Bad and doubtful debts reserve
The Income Tax Officer rejected the claim
On appeal the Appellate Assistant Commissioner allowed the claim in part
The Tribunal however allowed the assessee s claim in full in further appeal while rejecting the Revenue s appeal against AAC s order
At the instance of the Revenue the Tribunal referred the matter to the High Court
The High Court answered the reference partly in favour of the Revenue by negativing the claim as to forfeited moneys reserve and 399 restricting the quantum of amount allowed by the AAC regarding capital reserve as the assessee did not seek a reference against it
Hence the appeal by Revenue by Special Leave
In the Special Leave Petition No SLP C 4815A77 the High Court s rejection order of the revenue s request under section 2562 for calling for a case against the Tribunal s findings regarding the Gratuity Reserve Reserve for Sepcial Survey Reserve for contingencies fleet Replacement reserve Reserve for exempted Profits under section 84 of the Income Tax Act Reserve for Investment depreciation and Dividend Equalisation Reserve but allowing only in relation to the Reserve for special Survey come to be considered
Allowing the two civil appeals in part and dismissing the Special Leave Petition the Court  HELD 1
In the facts and circumstances of the case except the obsolescence Reserve and the forfeited moneys reserve all the Reserves namely capital Reserve Stocks and Stores Reserve Bad and doubtful debts reserves Loans and Insurance Reserve Investment reserve and rehabilitation reserve are to be included in the computation of capital according to the provisions in the Second Schedule to the  2
Where the liability has actually arisen or anticipated legitimately by the assessee though the quantum of the liability has not been determined to meet such present liability cannot be treated as reserve
A fund however created for payment of a liability which had not already arisen or fallen due but orly a provision with regard to the sum that might become liable to be paid is other reserve within the meaning of rule 1 of second schedule and should be taken into account in computing the capital of the company for the purpose of the Companies Profit Surtax Act 1964
Except the item relating to Reserve for special survey it is not necessary to call for any statement of the case in respect of other items in SLP C 4815A77
406G H 407A Commissioner of Income Tax Kanpur vs The Elgin Mills Ltd Kanpur 1986 3 SCR P 408 followed