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

1. These two connected appeals, one by the Commissioner of Income-tax, Bombay, and the other by the Century Spinning and Manufacturing Co. Ltd., arise out of the judgment and order of the Bombay High Court delivered on a reference made by the Income -tax; Appellate Tribunal,The two questions of law referred by the Tribunal were as follows.(1) Whether the, amount of Rs. 5,08,637/- is a part of the reserves of the assesses company as on l-4-1946, within the meaning of R. 2(1) of the Rules in Sch. II to the Business Profits Tax Act, and(2) Whether the profits of the assessee Company from 1st January to 1st April, 1946, should be included in the said reserves as on lst April, 1946.The High Court answered the first question in the affirmative and the second in the negative.The accounting- year followed by the assesses is the Calendar year and the chargeable accounting period is 1-4-1946 to 31-12-1946, in respect of the profits ending withThe profits according to the profit and loss account were Rs. 90,44,677 subject to the provisions for depreciation and taxation. After making provisions for these, the balance of Rs. 5,08,637 was carried to the balance-sheet.4. Two contentions were raised on behalf of the assesses before the Income-Tax Officer, the first being whether the aforesaid sum could be called a reserve within the meaning of R. 2(1) of the Rules in Sch. II. Business Profits Tax Act and whether it should be included in its reserves while determining the capital on 1-4-1946; the second that the proportionate profits of the assessee for three months, between 1-1-1946 and 1-41946, should also be included in the said reserves.The Income-Tax Officer rejected the contention holding that "A reserve represents profits set apart for some specific or general purpose and therefore profits which have not been so set apart cannot be treated as forming part of reserves for the purpose of inclusion in the capital." This order was confirmed on appeal by the Appellate Assistant Commissioner but was set aside by the Income-Tax Appellate Tribunal. Thereupon the Tribunal formulated the two questions aforementioned for reference to the High Court under S. 66 (1)of the Act, read with S. l9, Business Profits Tax Act of 1947. As already stated the High Court decided the first question in favour of the assessee and the second in favour of the department. Hence the two appeals.

Reasoning:
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.