# THE FIRST NATIONAL CITY BANK v. THE COMMISSIONER OF INCOME-TAX

- **Citation:** [1961] 3 S.C.R. 371
- **Court:** Supreme Court of India
- **Decided:** 1961
- **Bench:** J. L. Kapur, M. HrnAYATULLAH, J.C. Shah
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/the-first-national-city-bank-v-the-commissioner-of-income-tax-2011
- **Pages:** 10

## Headnote

Business Profits Tax-" Undivided profits ", if fell within the
word" reserves "-Business Profits Tax Act, I947 (XX! of r947),
Sch.[[, Rule 2(I).
The appellant, a non-resident Banker incorporated under
the National Bank Act of the United States of America with its
Head Office in America, was assessed under Business Profits
Tax Act, 1947· Under the Treasury Rnles of the United States
of America and Instructions for preparation of reports of conditions by the National Banking Association certain sums had to
be specifically allocated under s. 52n of the Revised Statute
of the United States, and the appellant bank was required to
keep a certain sum of money under the head " undivided profits" and that was an integral part of the capital structu.c.e.
The reason for the existence of this fund was that when losses
occurred according to the practice they could be charged against
"undivided profits", i.e., profits set apart after provision for
expenses and taxes etc. for continuous use in the business of the
Bank. The appellant contended that in computing the amount
for the purpose of "abatement" it was entitled to include the
"undivided profits" which fell within the word " reserves".
The question was whether the large sum of money shown
as "undivided profits" was a part of the reserves.
Held, that the amount designated as "nndivided profits"
was a part of the reserves and had to be taken into account
when computing the capital and reserves within Rule 2(1) of
Sch. II of the Business Profits Tax Act, 1947.

## Text

I
3 S.C.R.
SUPREME COURT REPORTS
371
answered in the affirmative in favour of the appellant.
1961
The appeals are, therefore, allowed and the judgments Dharamvir DAir
and . orders of the High Court are set aside. The Th c v. . .
I
'JI h
h'
.
h' C
t
d .
th
' omm1ssioner
appe !ant w1
ave
IS costs m t IS our an m
e
of Income-•••,
High Court. One hearing fee.
BihaY & Orissa
Appeals allowed.
THE FIRST NATIONAL CITY BANK
v.
THE COMMISSIONER OF INCOME-TAX,
BOMBAY CITY.
(J. L. KAPUR, M. HrnAYATULLAH and J.C. SHAH, JJ.)
Business Profits Tax-" Undivided profits ", if fell within the
word" reserves "-Business Profits Tax Act, I947 (XX! of r947),
Sch.[[, Rule 2(I).
The appellant, a non-resident Banker incorporated under
the National Bank Act of the United States of America with its
Head Office in America, was assessed under Business Profits
Tax Act, 1947· Under the Treasury Rnles of the United States
of America and Instructions for preparation of reports of conditions by the National Banking Association certain sums had to
be specifically allocated under s. 52n of the Revised Statute
of the United States, and the appellant bank was required to
keep a certain sum of money under the head " undivided profits" and that was an integral part of the capital structu.c.e.
The reason for the existence of this fund was that when losses
occurred according to the practice they could be charged against
"undivided profits", i.e., profits set apart after provision for
expenses and taxes etc. for continuous use in the business of the
Bank. The appellant contended that in computing the amount
for the purpose of "abatement" it was entitled to include the
"undivided profits" which fell within the word " reserves".
The question was whether the large sum of money shown
as "undivided profits" was a part of the reserves.
Held, that the amount designated as "nndivided profits"
was a part of the reserves and had to be taken into account
when computing the capital and reserves within Rule 2(1) of
Sch. II of the Business Profits Tax Act, 1947.
CIVIL APPELLATE JURISDICTION:
Civil Appeal
No. 315/1958.
Appeal by special leave from the judgment and
order dated February 5, 1957, of the Bombay High
Court in I.T.R. No. 34/1956.
Kapur].
I96I
January 6.
372
SUPREME COUR'I' REPOR!rs
[i961]
'96'
R. J. Kolah and I. N. Shmff, for the appellant.
The First National
A. N. Kripal and D. G;upta, for the respondent,
City Bank
1961. January 6. The Judgment of the Court was
v.
delivered by
The Commissioner
of Income-tax,
KAPUR, J.-This is av appeal against the judgment
Bombay City
and order of the High Court of Judicature at Bombay
Kapur].
in Income-tax Reference No. 34 of 1956. The appellant is a non-resident Bank incorporated under the
National Bank Act of the United States of America
with its head office in that country and with branches
all over the world including some branches in India.
It was assessed under the Business Profits Tax Act
(Act XXI of 1947), hereinafter termed the "Act", in
respect of the chargeable accounting periods:-
1-4-1946 to 24-12-1946,
25-12-1946 to 24-12-1947,
25-12-1947 to 23-12-1948, and
24-12-1948 to 31-3-1949
and the sole question for decision in this appeal is the
meaning of the word "reserves" in R. 2(1) of
Schedule 2 of the Act and how the capital of the
appellant during the above-mentioned chargeable
accounting periods has to be corn pu ted for the purpose of allowing the " abatement" under the Act.
The appellant contended that in computing the
amount for the purpose of abatement, it was entitled
to include what is termed in the United States "Undivided Profits ", the contention being that this item
falls within the word " reserves" in R. 2( l) of Schedule II of the Act which provides:
"Where the company is one to which rule 3 of
Schedule I applies, its capital shall be the sum of
the amounts of its paid-Up share capital .and of its
reserves in so far as. they have not been allowed in
computing the profits of the company for the purpose of the Indian Income-tax Act, 1922 (XI of
1922), diminiB'hed by the cost to it. of its investments or other property the income from which is
not includible in the profits, so far as that cost
exceeds any debt for money borrowed by it."
I
•·
a s.c.:a,;
SUPREME COURT REPORTS
373
h d
I
f
II h
r961
. It is not necessary to give t e
etai s o a t e
_
years; but it will be sufficient as an illustration if wen. F;,,1 Nation•I
were to confine ourselves to the "Undivided Profits"
City Bank ·c·
in the Balance Sheet as on December 31, 1946, wherev.
in the relevant entries were as follows :
TMC.,...mission.r
of Imome·W.
Ca pita]
. $ 77 ,500,000·00
Bombay City
Surplus..
. ..
$ 152,500,000·00
Undivided Profit ...
$
29,534,614·21
Kapur J.
The Report of the Directors dated January 14,
1947, was as follows:
.
"At the year-end, Capital of the Bank remains
at$ 77,500,000 surplus has increased to $152,500,000
by the transfer of$ 10,000,000 from Undivided Profits. After this transfer, Undivided Profits are
$ 29,534,614 an increase of $ 240,376 from a year
ago. The Trust Company has Capital of $10,000,000
surplus of $ 10,000,000 and Undivided Profits of
$ 8,097,020. The two institutions thus show tota.l
capital funds, that is Capital, Surplus and Undivi<l·
ed Profits of $ 287,631,634 or $ 46·39 per sharo
compared with S 44·60 per share at the end of
1945. ,,
According to the Balance Sheet of 1948, capital
funds since 1939 had increased from$ 169,768 thousands to $ 320, 795 thousands in the year 1948 and
there had bee11. a progressive increase both in what is
called "Surplus" as well as "Undivided Profits'', the
former increased from $ 62,500 thousands to $ 182,500
thousands and the latter from $ 19, 768 thousands to
$ 50, 795 thousands. The question in this case is
whether this large sum of money shown as "Undivided Profits " is a part of the Reserves or is equivalent
to the inallocated amount carried forward at the end
of a year of account in the balance of Profit &
Loss Account as we know it. It was the sum of
$ 20,534,614•21 and similar sums for tlie other chargeable Accounting Periods which are the subject matter
of controversy in this appeal. Both the Inco!ne-tax
Officer and the Appellate Assistant. Commissioner
excluded these amounts in determining the capital of
the Bank under R. 2(1) of Schedule II on the ground
that they were not a part of the reserves of the Bank.
374
SUPREME COURT REPORTS
[1961]
~~
The appellant took an appeal to the Income-tax
Th• First National Appellate Tribunal which was dismissed on the
City Bank
ground that " Undivided Profits " meant nothing
v.
more than the " Balance of the profits and Joss
The Commissioner account" and that no distinction could be draw1:
of Ineome-tox
J
b
·
th
J t
d ·
h
B
b
c·i ' mere y
ecause m
e nomenc a ure use
m t e
om ay •Y
United States, the amount was shown as" Undivided
Kapur J.
Profits "
and not balance of the profit and Joss
account. At the instance of the appellant the following question of Jaw was referred to the High Court:
" Whether on the facts and in the circumstances
of the case 'Undivided Profits' of $ 29,534,614·21
shown in the condensed statements of conditions as
of December 31, 1946, can be treated as reserves
and added to the capital, as required by rule 2(1) of
Schedule II to the Business Profits Tax Act for the
chargeable
accounting
period
25-12-19!6
to
24-12-1947?"
In its order the Tribunal said that the Treasury Rules
in United States divided capital account into four
different heads, Capital, Reserve, Surplus and the
Undivided Profits. The reserves are really reserves
for liabilities including the reserves for dividends.
" The general reserves as shown by the balance sheet
in India is equivalent to the Surplus. The undivided profits is equivalent to the balance of profit and loss
account." In the statement of the Case submitted
to the High Court, the Appellate Tribunal stated that
the question whether the Undivided Profits meant
the same thing as balance of the profit and loss
account was a question of fact and it did not matter
what name was given to it. But this was the very
question which was referred to the High Court.
The High Court after referring to the Directors'
Report to the shareholders held ,that the Undivided
Profit of $ 29,534,614·21 did not constitute "reserves"
because no direction had been given in regard to it, it
had never been transferred to any re~erve and had
never been earmarked for any particular purpose and
that the only act of ·volition on the part of the
Directors of the Bank was the transfer of 10 million
3 S.C.R.
SUPREME COURT REPORTS
375
dollars to the Surplus. In its judgment the High
I96I
Court said :
The First Nalio11&
"It is true that these large amounts (of UnCity Bank
divided Profits) remain with the Bank, that the
v.
Bank uses them, that business is carried on with The Commissio--
the help of those funds and that they are as much
o~In~ome~:"
capital of the Bank as capital in the strict sense of
om ay 'Y
the term. "
Kapur].
The High Court however held that they did not satisfy
the test laid down by the Supreme Court in Century
Spinning & Manufacturing Go. Ltd. v. C.J.T., Bombay(')
as the amount was not transferred to any reserve and
there being no act of volition on the part of the Directors this could not be regarded as Reserve. The
correctness of this view is challenged before us.
The Directors' report dated January 14, 1947, shows
that the surplus increased as a result of the allocation
made by the Directors, by IO million Dollars, which
was taken from Undivided Profits and the Undivided
Profits themselves increased to $29,534,614"21 which
was an ·increase of $240,376 in the year 1946 and
therefore the Capital Funds of the company which
included Capital, Surplus and Undivided Profits along
with similar items from the Trust Company had
increased considerably which was reflected in per share
increase, i.e., 44·60 per share at the end of 1945 to
46'39 per share at the end of 1946 thus showing that
it was the result of an act of the Directors that Surplus
was increased and a particular sum was left in the
Undivided Profits.
It was contended that no sum could be treated as
' Reserves' unless the Directors recommended it to be
so allocated and it was so adopted by the shareholders. But this argument ignores the evidence
placed by the appellant. Under the Treasury Rules
of the United States of America containing "Instructions for Preparation of Reports of Condition by
National Banking Associations", certain sums had to
be specifically allocated under s. 5211 of the revised
Statute of the United States (Title 12, U. S. C. 161).
Items 25 to 28, according to these instructions, deal
(1) (1954] S.C.R. 203.
376
SUPREME COURT REPORTS
[1961]
' 96'
with Ca.pita.I Account. Item 26 deals with 'Surplus'
The First -;ationala.nd item 27 with 'Undivided Profits' and item 28 with
Citv Bank
'Reserves' (and retirement account for preferred
· v.
stock). The following Reserves come under item 28 :-
The Commission.,,
· (a) "Reserve for dividends payable in oommon
of Imome-ta:r,
stock. ''
Bonibay City
f
d 1
d' 'd
(b) "Reserves or other un ec a.red · 1v1 ends."
Kapur J.
(c) t'P Retirement account for preferred stock. "
( d) " Reserves for contingencies, etc. "
Item 29 was as follows:-
" Total capital accounts". This item iR the sum
of items 25 to 28, inclusive.
Along with this the appellant has placed a copy of
the letter from the Deputy Controller of Currency,
Washingtont the relevant portion of which is as
follows :....:.
··
" [n connection with this matter we wish to assure
you that your position as stated is in complete
accord with that of the Office of the Comptroller of
the Currency. In the United States, the 'Undivided
Profits' as reflected in the accounting of a bank
actually represents a part of its crapital funds.
All
of the other bank supervisory agencies in the United
States consider the 'Undivided Profits' of a bank as
a part of its capital funds.
In any calculation for
the pllrpose of determining the adequacy of
capital in a commercial bank in the United States,
the supervisory authorities include
'Undivided
Profits' as an integral part of the capital structure
as it would not be possible otherwise to make an
accurate computation. When losses occur in banks,
it is the usual practice in many banks to charge
them against the ' Undivided Profits '
account
which by any reasoning would be inappropriate if
the account were regarded as
'Undistributed
Profits'. In commercial banks in the United States,
it is not customary to maintain any account that
could be regarded specifically as 'Undistributed
Profits' in the same sense as applied to similar
acoovnts in the ot,her corporations in India. The term
' Undivided Profits' simply follows a bank account-
- ing nomenclature used in the United Sta,tes to
3 f.fC.R.
.
"
SUPWEME COU~T :j:tEPQR;rS
377
designate profits set .aside, after
provi~io.ns ,.for
1961
expenses and t11-xes, dividends .and reserves., . for
. --N .
1
"
t'
f t
·
· h · b
.,1 ·
f th b
k,T/ie Firsl
al<ona
con muous
u Ure use m t e
JiSlll!JSS ·'?
e an
Cit:; Bank
and it bears a clos'e, if not idenli.c11-l, ·rel.ationship to
•
v.
the ,Earner.! Surplhs .A'ccount \}f,ali Jn:dustrial corpo- Tho Commissionor
ration. "
.
,
of Income-tax,
Balance sheets of three other banlrn of the Unite'd
iombay Ciiy '
States relied on by the appeUant 'show that Capital
[{a~:.J.
Fund comprises three kinds 'Of· ftlnds, i.e., Capital,
.Surplus and Uiicl.ivided Profits. 'Th,e .documents placed
on the record show tha~ 'these .thr~\l different kinds of
funds put toget.her ma)rn up what is called. "Capital
Fund". The creatidn and mlJ,intenance of the item '
known as' Un.divided Profits -is a requiremeift .of the
Treasury 'Rules which are made under the Statute
and therefore it cannot oe said that the amount of
Uμ,pivided' Profits .iri the-)3alai10e Sheet was not
allocated as a result of .either ·a- resolutton of the
\'
.
- .
Directors,
accept~d by
t)l.!l'
s~areholders or on
'.l.Ccount . of the
'requirei]l.e~ts .of, the law.
The
"Undivided Profits" hav.e· to be empli;>ye<;l in the
manner indicated by the' l~tter' q( the Deputy Con-
- - -
troller of QurrenQy. They _a,r/' set NP for exftenses,
taxes, dividends ana reserves f(>r continuous use;fn the
. business· of the Bank an,d ·are a par~ of ·'the ·capital
f1mds 'and an integral part b~ the capi.~al structure and
without it, it would no£ be' possib!J to' make an
accurate computation. ·The reason for 'the. existence
of this fund, as shown by th!l.t letter is ti).at 'vhen
therfii.are losses, they pan be charged' aga.inst "U ndividea Profits" which expression means profits set apart
a,fter provi&ion for expenses ~nd .taxes etc. for con-
~nuous use .in th~ business of the Bank.
There, is a differegc~ betw~eq the syst~m of il.cc<;iqnting of Banking 9~prpani~s ',in Jndia ans! the United
States; .tlie failure to appteci!lote this difference'has
Jed the Appellate Tribunal as well as the High Court to
arrive at an erroneous conclusion. In India at the
end of an y~ar of accoun,b the unallocated profit or loss
is <Carried fqrward to· the account of the.,n.ext year and
such unallocated aruo'unt gets:'nierged :in ,the acbount
of th:Lt year.
;J:n the system uf aoooun\ing in the
48
'I
-
378
SUPREME COUR'l' REPORTS
(1961]
1961
U.S. A. each year's account is self-contained and
-
nothing is carried forward. If after B,llocating the
The ~;;stBNai;,onal profits to diverse heads mentioned above any balance
'Y v."n , remains, it is credited to the " Undivided Profits "
The commissioner whieh become part of the capital fund. If in any year
o' Income-tax,
as a result of the allocation there is a loss the accumula1:-
Bombay c;tf ed undivided profits of the previous years are drawn
Kapur].
upon and if that fμnd is exhausted the Banking Company draws upon the surplus. In its very nature the
Undivided Profits are accumulation of amounts of
residue on hand at the end of year of successive periods
of accounting and these amounts are by the prevailing accounting practice and the .Treasury directions
regarded as a part of the capital fund of the Banking
Company.
The nature of" Undivided Profits" was considered
by the Supreme Court of America in Fedelity 'l'itle
and Trust Co. v. United States (1 ). In that case a suit
was brought by the Fedelity Co. to recover the tax
assessed on its whole capital and undivided profits
under s. 2 of the Spa.nish War Revenue Act. In the
Supreme Court it was contended by the company
that th11 terms "Capital''," Surplus" and "Undivided
Profits" have a precise and definite meaning in the
business of banking and that Undivided Profits are
not surplus and cannot therefore be taxed as " Surplus ". The Government on the other hand contended that the undivided profits were taxable as being a
part of Capital or Surplus. The Court held that
"Undivided Profits" were taxable as being a part of
the Capital employed. Mr. Justice Brandeis delivering the opinion of the Court said at p. 955:
" The Act declares that 'in estimating capital
surplus shall bq included,' and that the ' annual
tax shall in all cases be computed on the basis of
the capital and surplus for the preceding fiscal
year" ················--·······-·········-························
As it is the use or employment of capital in banking, not mere possession thereof by the banker,
which determines the amount of tax, the fact that
a portion of the capital so used or employed is
(1) 66 L. E<!. 9,53 : (1921) 259 U.S. 304.
•
~
\'
. "
I
3 S.C.R.
SUPREME COURT REPORTS
379
designated 'undivided profits ' is of no legal signix96x
fi
,,
canoe.
.
The First National
As to what the word "Reserves" as used m the
City Bank
Business Profits Tax Act connotes, was considered by
v.
this Court in the Commissioner of Income-tax v. Gen- The Commissioner
tury Spinning & Jlf anufacturing Co. Ltd. (1 ). It was
0! Income-tax,
held that the true nature and character of a sum disBombay City
puted as reserve was to be determined ""'.ith reference
Kapur J.
to the substance of the matter. The amount in dispute
in that case was the profits after the deduction of
depreciation and tax which amount was carried to the
Balance Sheet and was later recommended by the
Directors to be appropriated mainly to dividends and
balance to be carried forward to the next year's
account. Thus on the crucial date, i.P.., April I, 1946,
from which the Chargeable Accounting Period began
the sum in dispute had not been declared as reserve;
on the other hand the Directors had earmarked it for
distribution as dividend and it remained as a mass of
undistributed profits available for distribution. At
page 209 Ghulam Hassan J. said:-
"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
undistr.ibuted profits on the 1st January, 1946,
cannot automatically make it a reserve .............. .
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A reserve in the sense in which it is used in rule 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 .................. "
Applying this test to the disputed sum, it cannot be
said that the amount is not "Reserve" within the meaning of the Rules.
As is shown by the instructions
under s. 5211 of the Revised Statute of the United
States and the letter of the Deputy Controller referred
to above, the appellant bank was required to keep a
certain sum of money under the head " Undivided
Profits " and that is an integral part of the capital
(I) [1954] S.C.R. 203.
380
SUPREME COURT REPOl{TS
[1961]
x96x
structure. Under these circumstances it would be
Th F . -,-N ,.
1 erroneous not to treat the amount of "Undivided
' "'
a iona u
fi
"
f h
· J f
d
City Bank
i: ro ts
as a part o t e capita un .
v.
In our opinion therefore the amount designated as
1"he Commissioner "Undivided Profits " is a part of the reserves and has
0£
In~ome~~., to be taken into account when computing the capital
om ay "Y
and reserves within R. 2(1) of Schedule II of the Act.
Kapur J.
The question which was referred by the Tribunal
should have been decided in the affirmative and in
favour of the appellant and the amount should have
been added to the ca pita! as allowed by R. 2( 1) for the
Chargeable Accounting Periods. In the result the
appeal is t1Ilowed.
The appeIIant will have its costs
in this Court and in the High Court.
I96I
January zo.
Appeal allowed.
K. A. RAMACHAR AND ANOTHER
v.
COMMISSIONER OF INCOME TAX, MADRAS.
(J. L. KAPUit, M. HrnAYATULLAH and J.C. SHAH, JJ.)
Income-tax-Assessee assigning portion of his profits of partnership firm to his wife a11d daughters-Such profits, if can be included in the asscssec's total income for purposes of assessmcnt-Incometax Act, I922 (II of I922), s. I6(I)(c).
One Rangachari, a partner of a partnership firm, assigned by
means of a deed of settlement a fourth share of the profits of the
fir1n each to his 'Nife, a married adult daughter and a minor
daughter for 8 years with the right to receive the said share of
profits absolutely and exclusively from the firm.
The question
which arose before the High Court on a reference under s. 66(r)
of the Income-tax Act was "Whether the inclusion in the
assessce's total incnme of the profits settled by him on his wife
and two daughters is justifie<l in law?" The assessee Hangachari
relying on the rule laid down by the Privy Council in Bijoy
Singh Vudhuria's case cL1irned that the amounts payable to his
v.•ife and tYl'O daughters never became his inco1ne, being diverted
by an overriding title and that those amounts could not be
included in his total income for the purposes of assessment being
excluded by reason of the third proviw to s. 16(1)(c) of the
Income-tax Act.
The High Court held that the third proviso
was not attracted and that the income had accrued to the assessee
in the first instance, and had then Leen applied for payments
under the deeds. On appeal with a certificate of the High Court:
Held, that the answer given by the High Court was co:rect.
!
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