Case: State Bank of Patiala, Patiala Vs. Commissioner of Income Tax, Patiala

was reduced from the value of the assets. It was ;not the Revenues case that the provision for bad and doubtful debts provided was less that 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 the very nomenclature, this was not a reserve. The true nature of the transaction has to be examined." (emphasis supplied)And again at p. 748 the Court concluded, thus:- "It may be mentioned that where the liability has actually or is anticipated leqitimately by the assessee though the quantum of the liability has not been determined, a fund to meet such present liab ility cannot be treated as "reserves". A fund, however, created for payment of a liability which had not alreads arisen or fallen due but is only a provision with regard to the sum that might become liable to be paid is "other reserves " within the meaning of rule 1 of the Second Schedule and should be taken into account in computing the capital of the company for the purpose of the Companies (Profits) Surtax Act, 1964." * (emphasis supplied) 12. A fair reading of the above decisions would go to show that if the transfer of amount is made ad hoc, when there is no known or anticipated liability, such fund will only be treated as reserve. In this case, substantial amounts were set apart as reserves No amount of bad debt was actually written off or adjusted against the amount claimed as reserves. No claim for any deduction by way of bad debts were made during the relevant assessment years. The assessee never appropriated any amount against any bad and doubtful debts. The amounts throughout remained in the account of the assessee by way of capital and the assessee treated the said amounts as "reserves" and not as "provisions" designed to meet liability, contingency, commitment or diminution in the value of assets known to exist at the relevant dates of balance sheets. These facts have been found by the Tribunal. On the facts, the amount set apart as re serves cannot be said to be so earmarked, when ans liability has actually arisen or was anticipated by the assessee. It cannot be said either, that the amounts set apart out of the profits were designed to meet any known liability, that exiisted at the date of the balance-sheet. Tested in the light of the decisions of this Court, referred to hereinabove, it appears to us, that the amounts set apart towards bad and doubtful debts in these cases are "reserves" qualifying for appropriate relief under rule l(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act. 13. We are afraid that the High Court has grossly misunderstood the following observations of this Court contained in Commisioner of Income-Tax vs. Saran Engineering Co. Ltd. at p. 748. "It may be mentioned that where the liability has actually arisen or is anticipated leigitimately by the assessee though the quantum of the liability has not be en dstermined, a fund to meet such present liability cannot be treated as "reserves"." (emphasis supplied) 14. The High Court has taken the view that the "fund created or a sum of money set apart to meet an y liability which the assessee "can reasonably and legitimately anticipate " on the date of preparation of the balance sheet, is the same, as in a case "where the liability has actually arisen", (a present known liability) and the fund to meet such liability cannot be treated as reserve". In the view of the High Court, since the assessee is a banking company, it would be "reasonable and leqitimate to assume" that in the course of its business, "it is bound to have" bad and doubtful debts fo r which "it may", in anticipation, make a provision in the balance sheet by having a separate fund or an account to meet such anticipated liability We are afraid that the aforesaid assumption is totally unjustified and proceeds on mere surmises and conjectures. This is not a case, when at the time fund is earmarked, there is a known liability one which has either arisen or anticipated legitimately, by the assessee - and the fund to meet such eventuality cannot be treated as "reserves". Th e observations of this Court that the liability should be one "which has actually arisen or is anticipated leqitimately by the assessee", cannot be extended to hold, that in the case of an assessee carrying on banking business, it is "bound" or "can reasonably anticipate" on the date of the preparation of balance sheet "bad and doubtful debts", for which "it ought", in anticipation, make a provision and such provision for anticipated liability should be equafied with known and existing liability and should be construed as a provision.The question in such cases, is whether the liability was "known" or "anticipated" on the date when the balance sheet was prepared. The question is not whether the assessee "can anticipate" or "reasonably anticipate" on the date when the balance sheet was prepared about "the bad and doubtful debts". The High Court was in error in surmising that the assessee being a banking company is bound to have bad and doubtful debt s. It need not necessarily be so. It is not bound to anticipate on the date of preparation of balance sheet that all or any of its debts "are bound to be bad and doubtful". It all depends upon facts and circumstances. We are of the view that the High Court misunderstood the scope of the observations in Saran Engineering Co.s case (supra) and surmised that the observations quoted at page 748 wail even cover cases, where the liability was not factually anticipated on the date of the preparation of the balance sheet, but also will apply to cases, where the company "ought and can" anticipate on the date of preparation of the balance sheet.

Decision (1 = appeal accepted, 0 = rejected): 1

Explanation:
1[ds]12. A fair reading of the above decisions would go to show that if the transfer of amount is made ad hoc, when there is no known or anticipated liability, such fund will only be treated as reserve. In this case, substantial amounts were set apart as reserves No amount of bad debt was actually written off or adjusted against the amount claimed as reserves. No claim for any deduction by way of bad debts were made during the relevant assessment years. The assessee never appropriated any amount against any bad and doubtful debts. The amounts throughout remained in the account of the assessee by way of capital and the assessee treated the said amounts as "reserves" and not as "provisions" designed to meet liability, contingency, commitment or diminution in the value of assets known to exist at the relevant dates of balance sheets. These facts have been found by the Tribunal. On the facts, the amount set apart as re serves cannot be said to be so earmarked, when ans liability has actually arisen or was anticipated by the assessee. It cannot be said either, that the amounts set apart out of the profits were designed to meet any known liability, that exiisted at the date of the balance-sheet. Tested in the light of the decisions of this Court, referred to hereinabove, it appears to us, that the amounts set apart towards bad and doubtful debts in these cases are "reserves" qualifying for appropriate relief under rule l(xi)(b) of the First Schedule and rule 1(iii) of the Second Schedule of the Act13. We are afraid that the High Court has grossly misunderstood the following observations of this Court contained in Commisioner of Income-Tax vs. Saran Engineering Co. Ltd. at p. 74814. The High Court has taken the view that the "fund created or a sum of money set apart to meet an y liability which the assessee "can reasonably and legitimately anticipate " on the date of preparation of the balance sheet, is the same, as in a case "where the liability has actually arisen", (a present known liability) and the fund to meet such liability cannot be treated as reserve". In the view of the High Court, since the assessee is a banking company, it would be "reasonable and leqitimate to assume" that in the course of its business, "it is bound to have" bad and doubtful debts fo r which "it may", in anticipation, make a provision in the balance sheet by having a separate fund or an account to meet such anticipated liability We are afraid that the aforesaid assumption is totally unjustified and proceeds on mere surmises and conjectures. This is not a case, when at the time fund is earmarked, there is a known liability one which has either arisen or anticipated legitimately, by the assessee - and the fund to meet such eventuality cannot be treated as "reserves". Th e observations of this Court that the liability should be one "which has actually arisen or is anticipated leqitimately by the assessee", cannot be extended to hold, that in the case of an assessee carrying on banking business, it is "bound" or "can reasonably anticipate" on the date of the preparation of balance sheet "bad and doubtful debts", for which "it ought", in anticipation, make a provision and such provision for anticipated liability should be equafied with known and existing liability and should be construed as a provision.The question in such cases, is whether the liability was "known" or "anticipated" on the date when the balance sheet was prepared. The question is not whether the assessee "can anticipate" or "reasonably anticipate" on the date when the balance sheet was prepared about "the bad and doubtful debts". The High Court was in error in surmising that the assessee being a banking company is bound to have bad and doubtful debt s. It need not necessarily be so. It is not bound to anticipate on the date of preparation of balance sheet that all or any of its debts "are bound to be bad and doubtful". It all depends upon facts and circumstances. We are of the view that the High Court misunderstood the scope of the observations in Saran Engineering Co.s case (supra) and surmised that the observations quoted at page 748 wail even cover cases, where the liability was not factually anticipated on the date of the preparation of the balance sheet, but also will apply to cases, where the company "ought and can" anticipate on the date of preparation of the balance sheet