Case: Commissioner Of Income-Tax, Bombay City  Vs. The Century Spinning And Manufacturing Co. Ltd

is not denied that it was actually distributed. These being the facts, the question arises whether the amount in question can be called a reserve.7. The term reserve is not defined in the Act and we must resort to the ordinary natural meaning as understood in common parlance. The Dictionary meaning of the word Reserve is:"1 (a) To keep for future use or enjoyment: to store up for some time or occasion; to refrain from using or enjoying at once.(b) To keep back or hold over to a later time or place or for further treatment.6. to set apart for some purpose or with some end in view; to keep for some use.11. To retain or preserve for certain purpose" (Oxford Dictionary, Vol. VIII, p. 513).8. In Websters New International Dictionary, Edn, 2. p. 2118, Reserve is defined as follows :"1. To keep in store for future or special use: to keep in reserve; to retain, to keep, as for oneself.2. To keep back; to retain or hold over to a future time or place.3. To preserve."9. What is the true nature and character of the disputed sum must be determined with reference to the substance of the matter and when this is borne in mind, it follows that on 1-4-1946. which is the crucial date, the sum of Rs. 5,08,637 could not be called a reserve, for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on 28-2-1946, the Directors clearly earmarked it for distribution as divided and did not choose to make it a reserve Nor did the company in its meeting on 3-4-1946. decide that it was a reserve. It remained on the1st of April as a mass of undistributed profits which were available for distribution and not ear-marked as Reserve. On 1-1-1946, the amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The reserve may be a general reserve or a specific, reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits on 1-1-1946.cannot automatically make it a reserve. On 1-4-1946, which is the commencement of the chargeable accounting period, there was merely a recommendation by the Directors that the amount in question should be distributed as dividend. Far from showing that the Directors had made the amount in question a reserve, it shows that they had decided to ear-mark it for distribution as dividend. By the resolution of the shareholders on 3-4-1946, the amount was shortly afterwards distributed as dividend.The High Court appear to have been under a misapprehension as to the real position, for they observed :"It was open to the Directors to distribute the sum of Rs. 5,08,637 as dividends. They did not choose to do so and have kept back this amount. Therefore, by keeping back this amount they constituted it a reserve. A reserve in the sense. in which it is used in R. 2 can only mean profit earned by a company and not distributed as dividend to the shareholders but kept back by the Directors for any purpose to which it may be put in future. Therefore, giving to the reserves its plain natural meaning, it is clear that the sum of Rs. 5,08,637 was kept in reserve by the company and not distributed as profits and subjected to taxation. Therefore, it. satisfied all the requirements of R. 2."The Directors had no power to distribute the sum as dividend. They could only recommend, as indeed they did. and it was up to the share holders of the company to accept that recommendation in which case alone the distribution could take place. The recommendation was accepted and the dividend was actually distributed. It is, there-fore, not correct to say that the amount was kept back. The nature of the amount which was nothing more than the undistributed profits or the company, remained unaltered. Thus the profits lying unutilized and not specially set apart for any purpose on the crucial date did not constitute reserves within the meaning of Sch. II, R. 2(1).10. Reference was made to Ss. 131(a) and 132, Indian Companies Act. Section 131 (a) enjoins upon the Directors to attach to every balance-sheet a report with respect to the state of companys affairs and the amount if any which they recommended to be paid by way of dividend and the amount. if any, which they propose to carry to the Reserve Fund, General Reserve or Reserve Account. The latter section refers to the contents of the balance-sheet which is to be drawn up in the Form marked F in the III Schedule. This Form contains a separate head of reserves.Regulation 99 of the 1st Schedule. Table A, lays down"that the Directors may, before recommending any dividend set aside out of the profits of the company such sums as they think, proper as a reserve or reserves which shall, at the discretion of the directors, be applicable for meeting contingencies, or for equalising dividends, or for any other purpose to which the profits of the company may be properly applied. .. .. . .. "The Regulation suggests that any sum out of the profits of the company which is to be made as a reserve or reserves must be set aside before the Directors recommended any dividend.In this case the Directors while recommending dividend took no action to set aside any portion of this sum as a reserve or reserves. Indeed they never applied their mind to this aspect of the matter. The balance-sheet drawn up by the assessee as showing the profits was prepared in accordance with the provisions of the Indian Companies Act. These provisions also support the conclusion as to what is the true nature of a reserve shown in a balance-sheet.

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

Explanation:
1[ds]9. What is the true nature and character of the disputed sum must be determined with reference to the substance of the matter and when this is borne in mind, it follows that on 1-4-1946. which is the crucial date, the sum of Rs. 5,08,637 could not be called a reserve, for nobody possessed of the requisite authority had indicated on that date the manner of its disposal or destination. On the other hand, on 28-2-1946, the Directors clearly earmarked it for distribution as divided and did not choose to make it a reserve Nor did the company in its meeting on 3-4-1946. decide that it was a reserve. It remained on the1st of April as a mass of undistributed profits which were available for distribution and not ear-marked as Reserve. On 1-1-1946, the amount was simply brought from the profit and loss account to the next year and nobody with any authority on that date made or declared a reserve. The reserve may be a general reserve or a specific, reserve, but there must be a clear indication to show whether it was a reserve either of the one or the other kind. The fact that it constituted a mass of undistributed profits on 1-1-1946.cannot automatically make it a reserve. On 1-4-1946, which is the commencement of the chargeable accounting period, there was merely a recommendation by the Directors that the amount in question should be distributed as dividend. Far from showing that the Directors had made the amount in question a reserve, it shows that they had decided to ear-mark it for distribution as dividend. By the resolution of the shareholders on 3-4-1946, the amount was shortly afterwards distributed as dividend.TheDirectors had no power to distribute the sum as dividend. They could only recommend, as indeed they did. and it was up to the share holders of the company to accept that recommendation in which case alone the distribution could take place. The recommendation was accepted and the dividend was actually distributed. It is, there-fore, not correct to say that the amount was kept back. The nature of the amount which was nothing more than the undistributed profits or the company, remained unaltered. Thus the profits lying unutilized and not specially set apart for any purpose on the crucial date did not constitute reserves within the meaning of Sch. II, R.Regulation suggests that any sum out of the profits of the company which is to be made as a reserve or reserves must be set aside before the Directors recommended any dividend.In this case the Directors while recommending dividend took no action to set aside any portion of this sum as a reserve or reserves. Indeed they never applied their mind to this aspect of the matter. The balance-sheet drawn up by the assessee as showing the profits was prepared in accordance with the provisions of the Indian Companies Act. These provisions also support the conclusion as to what is the true nature of a reserve shown in a balance-sheet.11. We are of the opinion that the view taken by the Bombay High Court is erroneous and must be set aside. The appeal of the Commissioner of Income-tax is allowed with costs.12. As regards the second question Mr. Kolah, the learned counsel for the Company, frankly conceded that the view taken by the High Court on this part of the case is not open to challenge and is correct. The High Court held that the profits for three months from 1-1-1946 to 1-4-1946. were not reserves which would attract the application of R. 2 of Sch. II. With this conclusion we agree.