Case: Karamchand Premchand Private Limited Vs. Commissioner of Income Tax

B. P. JEEVAN REDDY J. 1. 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 opinion of the High Court "Whether, on the facts and in the circumstances of the case, the following amounts are to be included in the computation of capital of the assessee-company under rule I of the Second Schedule to the Super Profits Tax Act, 1963 (Rs.) (i) Amount set apart for contingent liability (taxation) 4, 50, 000 (ii) Amount set apart for proposed dividend 19, 90, 000 (iii) Reserve for depreciation fund in excess of the amount allowed as depreciation in income-tax 6, 77, 122 (iv) Excess provision in revenue accounts disallowed in income-tax assessment for the assessment years. 3, 61, 876 2. Though the question refers to four items, we are concerned in this appeal only with the first item. We shall, therefore, state the facts only in so far as they are relevant to the said item. 3. The assessee is a private limited company. The assessment year concerned is 1963-64. Some time in 1955-56, a notice was issued to the assessee under section 23A of the Indian 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 that a sum of Rs. 4, 50, 000 continued to remain and was shown as a provision set apart to meet the taxation liability which the assessee called a contingent 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, 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 the said judgment stood vacatedIn its assessment relating to the assessment year 1963-64 under the 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 Income-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 Tribunal. That appeal arose under the provisions of the Companies Profits Surtax 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 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. But no such order was passed with respect to the assessment year 1963-64). 4. Aggrieved by the judgment of the Tribunal, the Revenue obtained the aforesaid reference. The High Court answered the same in favour of the Revenue and against the assessee following the decision of this court in Metal Box Co. of India Limited v. Their Workmen. 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 not a reserve. In this appeal the correctness of the said view is questioned. Learned counsel for the appellant-assessee 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. v. CIT the distinction between provision and reserve is stated in the following words (at page 569) " The distinction between a provision and a reserve is in commercial accountancy fairly well known. Provisions made against anticipated losses and contingencies are charges against profits and, therefore, to be taken into account against gross receipts in the profit and loss account and the balance-sheet. On the other hand, reserves are appropriations of profits, the assets by which they are represented being retained to form part of the capital employed in the business. Provisions are usually shown in 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 proprietors interest. (See Spicer and Peglers Book Keeping and Accounts, Fifteenth edition, at page 42 )." 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 profit and loss account, a reserve is an 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 dealt with by the Companies Act, 1956." 5. 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 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.

Decision:
0[ds]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 profit and loss account, a reserve is an 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 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 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.