# VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC v. COMMISSIONER OF INCOME-TAX ANDHRA PRADESH, HYDERABAD September 250 !981

- **Citation:** [1982] 1 S.C.R. 789
- **Court:** Supreme Court of India
- **Decided:** 1982
- **Case number:** Civil Appeal No. 860 of 1973
- **Bench:** V.D. Tulzapurkar, E.S. Venkataramiah, Amarendra Nath Sen
- **Source:** https://unisonlegal.in/judgment/supreme-court-of-india/vazir-sultan-tobacco-co-ltd-etc-etc-v-commissioner-of-income-tax-andhra-pradesh-8320
- **Pages:** 47

## Headnote

Super Profits Tax Act, 1963 and Company's (Profits) Sur-tax Act, 1964Ru/e I of Second Schedule-Scope of-'' Provision" and "Reserve"·-DistinctionA sum of money transferred from current profits to general reserves-Dividend paid
from that fund-General reserve how calculated.
The Super (Profits Tax) Act, 1963 and the Company's (Profits) Sur-ta.
Act, 1964 (the scheme and main provisions of both of which are almost identical)
impose a special tax on excess profits earned by companies. The special t~ is
imposed in respect of so much of a company's "chargeable profits" of the
previous year as exceeded the "standard deduction"-
The term "chargeable
profit" is defined to mean th~ total income of an assessee computed under the
Income Tax Act, 1961 for aDy previous year and adjusted in accordance with
the provisions of that Act.
"Standard deduction" is determined by computing
the capital of a company in accordance with the rules laid down in the schedule.
The material part of rule 1 provides that before any amount or sum qualifies
for inclusion in capital computation of a company two conditions are required
to be fulfilled namely : (i) that the amount or sum must be a "reserve" and (b)
that it must not have been allowed . in computing the company's profit for the
purposes of Income Tax Acts, 1922 or 1961.
In their respective balance sheets, the assessees had shown under the heading
"current liabilities and provisions" appropriations of large sums of money for
taxation, retirement gratuity and dividends and claimed that for the purposes of
1<uper profits tax these sums should be regarded as "other reserves" within the
meaning of Rule 1 of Second Schedule to the Act and that for the computation
of capital they should be taken into account .
Treating these sums as "provisions" and not as "reserves", the Super
Profits Tax Officer determined the capital and the standard deduction by exclud~
ing them from the computation of the capital. He then levied super profits tax
on that portion of the chargeable profits of the previous year as exceeded the
standard deduction.
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While the Appellate Assistant Commissioner upheld the assessee's contention
ff
that these sums were "reserves" which should be taken into account for comput·
ing their capital, the Appellate Tribunal held that these were not "reserves" within
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SUPREME COURT REPORTS
[ 1982] I S.C.R.
the meaning of Rule 1 of the Second Schedule to the Act and as such could not
enter into capital computation.
On reference the High Court held that the sums set apart were not "reserves"
and so should be excluded in the computation of the capital for the purposes of
levying the super profits tax.
In Tax Reference no. 5 (a case under the Companies (Profits) Sur-tax Act,
1964) the assessee transferred from out of its current profits a large sum of
money to the general reserves and paid dividend to its shareholders from out of
the augmented general reserves.
On the question whether for computing the
capital for the purpose of sur-tax the general reserves should or should not be
reduced by the sum of dividend paid, the taxing authorities and the appeUate
tribunal ignored this amount holding that it was not a "reserve".
None of the items of appropriation either for taxation or for retirement
gratuity or for proposed dividend in the asses!!:ees' cases had been allowed in
computing their profits under the Income Tax Act, 1961.
I
HELD : [per Tulzapurkar & Venkataramiah, JJ]
~
The expressions' 'reserve" and "provision" have not been defined in the
Act.
Standard dictionaries, without making any distinction between the
two concepts, use them more or less S}nonymously connoting the same idea. But
since in the context of the legislation a clear distinction between the two is
implied it is essential to know the exact connotation of the two concepts and the
distinction as known in commercial accountancy. The rules for computation of
capital contained in the Second Schedule to the Act procee

## Text

_Characters 0–39,835 of 116,795. This is a partial read: ask again with offset=39835 for what follows._

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789
A
VAZIR SULTAN TOBACCO CO. LTD. ETC. ETC.
v.
COMMISSIONER OF INCOME-TAX
ANDHRA PRADESH, HYDERABAD
September 250 !981
(V.D. TULZAPURKAR, E.S. VENKATARAMIAH AND
AMARENDRA NATH SEN, JJ.]
Super Profits Tax Act, 1963 and Company's (Profits) Sur-tax Act, 1964Ru/e I of Second Schedule-Scope of-'' Provision" and "Reserve"·-DistinctionA sum of money transferred from current profits to general reserves-Dividend paid
from that fund-General reserve how calculated.
The Super (Profits Tax) Act, 1963 and the Company's (Profits) Sur-ta.
Act, 1964 (the scheme and main provisions of both of which are almost identical)
impose a special tax on excess profits earned by companies. The special t~ is
imposed in respect of so much of a company's "chargeable profits" of the
previous year as exceeded the "standard deduction"-
The term "chargeable
profit" is defined to mean th~ total income of an assessee computed under the
Income Tax Act, 1961 for aDy previous year and adjusted in accordance with
the provisions of that Act.
"Standard deduction" is determined by computing
the capital of a company in accordance with the rules laid down in the schedule.
The material part of rule 1 provides that before any amount or sum qualifies
for inclusion in capital computation of a company two conditions are required
to be fulfilled namely : (i) that the amount or sum must be a "reserve" and (b)
that it must not have been allowed . in computing the company's profit for the
purposes of Income Tax Acts, 1922 or 1961.
In their respective balance sheets, the assessees had shown under the heading
"current liabilities and provisions" appropriations of large sums of money for
taxation, retirement gratuity and dividends and claimed that for the purposes of
1<uper profits tax these sums should be regarded as "other reserves" within the
meaning of Rule 1 of Second Schedule to the Act and that for the computation
of capital they should be taken into account .
Treating these sums as "provisions" and not as "reserves", the Super
Profits Tax Officer determined the capital and the standard deduction by exclud~
ing them from the computation of the capital. He then levied super profits tax
on that portion of the chargeable profits of the previous year as exceeded the
standard deduction.
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While the Appellate Assistant Commissioner upheld the assessee's contention
ff
that these sums were "reserves" which should be taken into account for comput·
ing their capital, the Appellate Tribunal held that these were not "reserves" within
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SUPREME COURT REPORTS
[ 1982] I S.C.R.
the meaning of Rule 1 of the Second Schedule to the Act and as such could not
enter into capital computation.
On reference the High Court held that the sums set apart were not "reserves"
and so should be excluded in the computation of the capital for the purposes of
levying the super profits tax.
In Tax Reference no. 5 (a case under the Companies (Profits) Sur-tax Act,
1964) the assessee transferred from out of its current profits a large sum of
money to the general reserves and paid dividend to its shareholders from out of
the augmented general reserves.
On the question whether for computing the
capital for the purpose of sur-tax the general reserves should or should not be
reduced by the sum of dividend paid, the taxing authorities and the appeUate
tribunal ignored this amount holding that it was not a "reserve".
None of the items of appropriation either for taxation or for retirement
gratuity or for proposed dividend in the asses!!:ees' cases had been allowed in
computing their profits under the Income Tax Act, 1961.
I
HELD : [per Tulzapurkar & Venkataramiah, JJ]
~
The expressions' 'reserve" and "provision" have not been defined in the
Act.
Standard dictionaries, without making any distinction between the
two concepts, use them more or less S}nonymously connoting the same idea. But
since in the context of the legislation a clear distinction between the two is
implied it is essential to know the exact connotation of the two concepts and the
distinction as known in commercial accountancy. The rules for computation of
capital contained in the Second Schedule to the Act proceed on the basis of the
formula of capital plus reserve, a formula well known in commercial accountancy.
But since they occur in a taxing statute applicable to companies only these
expressions will have to be understood in the sense or meaning attributed to the1n
by men of business, trade and commerce and by persons interested in or dealing
with companies. Therefore, the meaning attached to these words in the Companies Act, 1956 would govern their construction for the purpose of these two
enactments. [800 C·H]
The broad distinction between the two expressions as judicially evolved by
this Court is that, while 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 protits, the· asset or assets by which it is represented being
retained to form part of the capital employed in the business. [801 F]
C.l.T. v. Century Spinning & Manufacturiag Co., 24 ITR 499 and Metal Box
Company of India Ltd. v. Their Workmen, 13 ITR 67 followed.
The Cornpanies Act, which enjoins upon the Board of Directors of every
company to lay before the annual general meeting of its shareholders an annual
balance sheet and a profit and loss account, enumerates the separate heads that
should be shown in the balance sheet, two of these items being "reserve" and
"provision". The definitions of these two expressions given in the Act show
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VAZJR SULTAN TOBACCO CO. V. C.J.T.
791
that if any retention or appropriation of a sum falls within the definition of
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"provision" it can never be a "reserve", But the converse is not true. If the retention or appropriation is not a "provision" that is, if it is not designated to meet
depreciation, renewals or diminution in value of assets or any known liability it is
not automatically a ''reserve'' and the question will have to be decided having
regard to the true nature and character of the sum so retained or appropriated
depending on several factors, including the intention with which and the purposes
for which such retention or appropriation had been made. [803 E·F]
8
Having regard to the type of definitions of the two concepts, if a particular
retention or appropriation of a sum falls within the expression "provision" then
that sum will have to be excluded from the computation of capital. If the sum
is in fact a "reserve" then it would be taken into account for the computation
of capftal. l804 B-C]
Where the assessee had set apart a sum of money to meet tax liability in
respect of profits earned during an accounting year, which liability was not
quantified, such setting apart for a known and existing liability, would be a
"provision" and could not be regarded as a "reserve". [806 A-C]
c
Kesorarri Industries and Co1ton Mills Ltd. v. Commissioner of Wealth Tax
D
(Central) Caicutta, 59 JTR 767 followed.
But if provision for a known or existing liability is made in excess of the
amount reasonably necessary for the purpose, such excess shou1d,,.be treated as
"reserve" and, therefore, would be includible in capital computation.
[806 E]
Since the assessee (in C.A. No. 860/73) had at no stage of the proceedings
before the Taxing Authorities or Appellate Tribunal or the High Court raised a
plea that the provision made by it for taxation was in excess of the amount
reasonably necesssary for the purpo~e and that such excess should be treated as a
"reserve'', the olea which needs investigation into facts, could not be allowed to
be raised for the first time in appeal before this Court. [807 F]
Ordinarily an appropriation to gratuity reserve will have to be regarded as
a provision made for a contingent liability, for, under a scheme framed by a
company- the 1iability to pay gratuity to its employee on determination of employment arises only when the employment of the employee is determined by death,
incapacity, retirement or resignation-an event (cessation of employment) certain
to happen in the service career of every employee. Moreover, the amount of
gratui1y payable is usuaJJy dependent on the employee's wages at the time of
determination of his employment and the number of years of service put in by
him and the liability accrues and enhances wilh completion of every year of
service; but the company can work out on an acturial valuation its estimated
liability (i.e. discounted present value of the liability under the scheme on a sden~
tific basis) and make a provision for such liability not all at once but spread over
t\ number of years. Jf by adopting such scientific method any appropriation is
made such appropriation will constitute a provision representing fairly accurately
a known and existing liability for the year in question; if however, an ad hoc sum
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SUPREME COURT REPORTS
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is appropriated without resorting to any scientific basis such appropriation would
also be a provision intended to meet a known liability, though a contingent one,
for, the expression 'liability' occurring in cl. (7)(1)(a) of Part III of Sixth Schedule
to the Companies Act includes any expenditure contracted for and arising
under a contingent liability; but if the sum so appropriated is shown to be in
excess of the sum required to meet the estimated 1iability (discounted present
value on a scientific basis) it is only the excess that will have to be regarded as a
reserve under clause (7) (2) of Part III to the Sixth Schedule. [807 G·H; 808 A·D]
In the instant case although the assessee had urged before the authorities
below that different treatment for the same item could not be given for purposes
of income tax assessment and super profits tax assessment the assessee did not
clarify by placing material on record as to whether appropriation was based on
any acturial valuation or whether it was an appropriation of an ad hoc amount
which has a vital bearing on the question, whether the appropriation could be
treated as a provision or reserve. In the absence of proper material the question
should be decided by the taxing authorities whether the amount set apart and
transferred to gratuity reserve by the assessee company was either a provision or
a reserve and if the latter to what extent. [812 C·E]
Standard Mills Co. Ltd. v. Commissioner of Wealth.Tax, Bombay. 63, I.T.R.
470 & Work,,,.n of William Jacks & Co. Ltd. v. Management of Jacks & Co.
Ltd; Madras, [1971] Supp. S.C.R. 450 followed.
Southern Railway of Peru Ltd. v. Owen [1957] A.C. 334 referred to.
The appropriations of an amount by the Board of Directors by way of
providing for proposed dividend would not constitute 'provision', for, the appro·
priations cannot be said to be by way of providing for any known or existing
liability, none having arisen on the date when the Directors made recommendation much less on the relevant date after the first day of the previous year
relevant to the assessment year in question. This by itself would not convert
the appropriations into "reserves•·. [813 E·F]
The tests and guidelines laid down by this Court in this respect are : (1) the
true nature and character of the appropriation must be determined with reference
to the substance in the matter, which means that one must have regard to the
intention with which and the purpose for which appropriation has been made
such intention and purpose being gathered from the surrounding circumstances.
A mass of undistributed profits cannot automatically become a reserve. Some
body possessing the requisite authority must clearly indicate that a portion
thereof has been earmarked or separated from the general mass of profits with a
view to constituting it either a general reserve or a specific reserve; (2) the
surrounding circumstances should make it apparent that the amount so earmark·
ed or set apart is in fact a reserve to be utilised in future for a specific purPose
on a specific occasion; (3) a clear conduct on the part of the Directo1s in setting
apart a sum from out of the mass of undistributed profits avowedly for the
purpose of distribution of dividend in the same year would run counter to a~y
intention of making that amount a reserve, (4) the nomenclature accorded to any
particular fund which is set apart from out of the profits would not be material
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VAZJR SULTAN TOBACCO CO. v. C.J.T.
793
or decisive of the matter; and (5) if any amount set apart from out of the profits
is going to make up capital fund of the assessee and would be available to the
assessee for its business purposes it would become a reserve liable to be included
in the capital computation of the assessee under that Act. [815 F·H, 817 G]
The relevant provisions of the Companies Act clearly show that Jcreating
reserves out of the profits is a stage distinct in point of fact and anterior in point
of time to the stage of making recommendation for payment of dividend and the
scheme of the provisions suggests that appropriation made by the Board of
Directors by way of recommending a payment of dividend cannot in the nature
of things be a reserve. [818 F-G]
Judged in the light of the above guidelines the ~·appropriations made by the
Directors for proposed dividend in the case of the concerned assessee companies
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did not constitute 'reserves' and the :concerned amounts so set apart would have
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to be ignored or excluded from capital computation. [818 H]
Standard Mills Co. Ltd. v, Commissioner of Wealth-tax Bombay, 63 I.T.R.
470, Metal Box Co. of India Ltd. v. Their Workmen, 73 ITR 67, First National
City Bank v. Commissioner of Income-Tax, 42 ITR 67 & Commissioner of Incometax (Central), Calcutta v. Standard Vacuum Oil Co., 59 !TR 685 followed.
D
Although under the Companies Act it is open to the Directors to recommend and the share-holders to approve payment of dividend from the current
year's profits or from the past year's profits and on transfer of a portion of
the current year's profit to the general reserve the augmented general reserve
becomes a congolmerate fund, having regard to the natural course of human
conduct it is not difficult to predicate that dividends would ordinarily be paid
out from the current income rather than from the past savings, unless the
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directors in their report expressly or specifically state that payment of divid~nds
would be made from the past savings. From the commercial point of view, if
any amount is required for incurring any expenditure or making any disbursement like distribution of dividends in a current year, ordinarily the same will
come out of the current income of the company if it is available and only if the
sum is insufficient then the past savings will be resorted to for the purpose of
incurring that expenditure or making that disbursement. Such a course would
F
be in accord with the common sense point of view. [822 C-F]
In the absense of express indication to the contrary the normal rule for a
comn1ercial concern would be to resort to current income rather than past
savings while incurring any expznditure or making any disbursement. (822 H]
Commissioner of Income-Tax, Bambay City-Iv. Bharat Bijlte Ltd. 107 ITR
30; & Comniissioner of Income-Tax, Bombay City-I/ v. Marrior (India) Ltd. 120
!TR 512 approved.
[per A.N. Sen, J.]
The amount set apart for payment of any dividend recommended by the
Board of Directors is not an amount set apart for meeting a known or existing
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SUPREME COURT REPORTS
[1982] I S.C.R.
liability and cannot be considered to be a "reserve" within the meaning of the
Act for the purposes of computation of the capital of the company. [832 F]
The Companies Act, 1956 provides for the preparation of annual b1l1nce
sheet in the psescribed form and laying it before the shareholders at the annual
general meeting. Regulation 87, Table A in Schedule I contemplates that the
Board may set aside out of the profits of the cotnpany certain sum as "reserve"
before dividend is recommended by it. The amount recommended by the Board
for payment of dividend is shown in the balance sheet under the head "provision°
and not under any head of ''reserve!'. The true nature and character of the sum
so set apart must be determined with regard to the substance of the matter which
in this case is that the sum set apart \Vas never intended to constitute a "reserve"
of the company. [833 F, 834 G]
In law the liability for payment of dividend arises only when the share·
holders accept the recommendations made by the Directors. Till then it is open
to the Directors to modify or withdraw their recommendation before it is accepted
by the shareholders and it is equally open to the shareholders not to accept the
recommendation in its entirety. Even so, for business purposes when the
Directors make any recommendation for payment of dividend and set apart any
amount for this purpose the Directors intend to make a provision and do not
create any reserve, as Directors know that their recon1rnendation is generally
accepted by the shareholders as a matter of course. T11erefore any amount set
apart for this purpose is understood by persons interested in company matters
and in dealing with companies to mean a provision for the payment of dividend
to the shareholders and is not understood to constitute a "reserve". [832 C-E]
Commissioner of Income-tax Bombay City v. Century Spinning and Manu·
facturing Co. Ltd. [19531 24 I.T.R. 499, Commissioner of Income Tax v. Standard
Vaccum Oil Co., [1966] 59 I.T,·R. 685, Metal Box Co. of Ltd. v. Their Workmen,
[1963] 73 I.T.R, 53, Commissioner of Income-tax v. Mysore Electrical Industries
Ltd., [1971] 80 I.T.R. 567 and Kesha Ram Industries and Cottun Mills Ltd v.
Commissioner of Wealth Tax (Central), Calcutta, [1966] 59 I.T.R. 767 referred to.
CIVIL APPELLATE JURISDICTION : Civil Appeal No. 860 of 1973.
From the judgment and order dated the I st September, 1972 of
the Andhra Pradesh High Court at Hyderabad in R.C. No. IO of
1971.
AND
Civil Appeal No. 1614 (NT) of 1978.
Appeal by Special Leave from the judgment and order dated
the 26th July, 1976 of the Calcutta High Court in J.T. Reference No.
454 of 1974.
AND
Review Petition No. 57 of 1980.
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VAZIR SULTAN TABACCO CO. v. C.l.T.
795
IN
Special Leave Petition (Civil) No. 4602 of 1977
From the judgment and order dated the 11th June, 1974 of the
Calcutta High Court in I.T. Reference No. 195 of 1969.
AND
Tax Reference Case Nos. 2 and 3 of 1977.
Income-tax Reference under section 257 of the Income-tax Act,
1961 drawn up by the Income-tax Appellate Tribunal, Bombay
Bench 'B' in R.A. Nos. 1223 and 1224 (Born.) of 1972-73 (J.;T. A.
Nos. 24 and 25 (Born.) of 1971-72.
AND
Tax Reference Case No. 5 of 1978.
A
B
c
Income Tax Reference under section 257 of the Income Tax
D
Act, 1961 made by the Income Tax Appellate Tribunal, Bombay
Bench "D" in R.A. No. 225 (Born.) of 1977-78 arising out of S.T.A.
No. 36 (Bombay)/ 1976-77.
A. Subbarao and Y.V. Anjaneyulu for the appellant in Civil
~~~8~n.
E
V.S, Desai, Dr. ~Debi Pal, Praveen Kumar and Anil Kumar
Sharma for the Appellant in C.A. 1614of1978 and for the Petitioner
in Review Petition No. 57 /80.
K.G. Haji and K.J. John for the Appellant in Tax Reference
F
Case Nos. 2 and 3 of 1977.
S.E. Dastur, S.N. Ta/war and K.J. John for the Appellant in
Tax Reference Case No. 5 of 1978.
S.T. Desai, J. Ramamurthi and Miss A. Subhashini for the
G
Respondent in Civil Appeal No. 860/73.
Miss A. Subhashini for the Respondent in Civil Appeal No.
1614 of 1978.
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S.C. Manchanda and Miss A. Subhashini for the Respondent in
Tax Reference Nos. 2 and 3 of 1977.
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SUPREME COURT REPORTS
(1982] 1 S.C.R.
S.C. Manchanda, Ani/ Dev Singh and Miss A. Subhashini for
the Respondent in Tax Reference Case No. 5/ 1978.
SP. Mehta and K.J. John for the Intervener.
· Dr. Debi Paul and K.J. John for the Intervener in Tax
Reference Case No. 5/1978.
The following Judgments were delivered :
TULZAPURKAR, J.
In these Civil Appeals and Tax Reference
Cases certain common questions of law arise for our determination
and hence all these are disposed of by this common judgment.
The
common questions raised are whether amounts retained or appropriated or set apart by the concerned assessee company by way of
making provision (a) for taxation, (b) for retirement gratuity and
(c) for proposed dividends from out of profits and other surpluses
could be considered as "other reserves" within the meaning of Rule
1 of the Second Schedule to the Super Profits Tax Act, 1963 (or
Rule I of the Second Schedule to the Company's (Profits) Sur-tax
Act, 1964) for inclusion in capital computation of the Company for
the purpose of levying super profit tax? The first three matters
concerning Vazir Sultan Tobacco Co. L1d; Hyderabad, Ballarpur
lndustries, Ltd; and M/s. Bengal Paper Mills Co. Ltd; Calcutta arise
under the Super Profits Tax Act, 1963 while the the Tax Reference
Cases concerning M/s. Echjay Industries Pvt. Ltd. and Hyco Products Pvt. Ltd. Bombay arise under the Companies (Profits) Sur-tax
Act,! 964.
Since Civil Appeal No. 860 of 1973 (Vazir Sultan Tobacco
Company's case) is compreher,sive and comprises all the three items
of apprc priation it will be sufficient if the facts in this case are set
out in detail so as to understand how the questions for determination
arise in these matters.
Vazir Sultan Tobacco Co. Ltd. was an
assessee under the Super (Profits) Tax Act, 1963.
For the assessment year 1963-64, for which the relevant accounting period was the
year which ended 30th September, 1962, for computing the chargeable profits ot that year for the purpose of levy of super profits tax
under the Act, the assessee company claimed that the appropriations
of a) Rs. 33,68,360 for taxation, (b) Rs. 9,08,106 for retirement
gratuity and (c) Rs. 18,41,820 for dividends (all of which items
were shown under the heading 'current liabilities and provisions' in
the concerned balance-sheet as at 30th Sept. 1962) should be regarI
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VAZIR SULTAN TOBACCO co. v. C.I.T. (Tulzapurkar, J.)
797
ded as "other reserves" within the meaning of Rule 1 of Second
Schedule to the Act and be included while determining its capital.
The Super Profits Tax Officer rejected the assessee's contention as
in his opinion all these items were "provisions'· ~nd not "reserves"
and as such these had to be ignored or excluded from the capital
computation of the assessee company and on that basis he deter·
mined the capital, and the standard deduction and levied super
profits tax on that portion of the chargeable profits of the previous
year which exceeded the standard deduction.
In the appeal preferred by the assessee company against the assessment, the Appellate
Commissioner upheld the assessee's contentions and held that tho3e
items were "reserves" and took them into account while computing
the capital of the assessee company.
In the further appeal preferred by the Super Tax Officer, the Income Tax Appellate Tribunal
accepted the Department's contention and held that these were not
"reserves" within the meaning of Rule I of the Second Schedule to
the Act and as such these could not enter into capital computation
of the assessee company.
In the Reference that was made under
section 256(1) of the Income Tax Act, 1961 read with s. 10 of the
Super Profits Tax Act at the instance of the assessee company the
following question of law was referred to the Andhra Pradesh High
Court for its opinion :
"Whether on the facts and in the circumstances of the
case the provisions (a) for taxation Rs. 33,68,360, (b) for
retirement gratuity Rs. 9,08,106 and (c) for dividends
Rs. 18,41,820, could be treated as 'reserves' for computing
the capital for the purpose of super profits tax under
Second Schedule to the Super Profits Tax Act, 1963 for the
assessment year 1963-64 ?"
The High Court on a consideration of several authorities
answered the question in respect of the three items in favour of the
Revenue and against the assessee company and held that the three
snms so set apart by the assessee company in its balance-sheet were
not "reserves" and had to be excluded in the computation of its
capital for the purpose of levying super profits tax payable on the
chargeable profits for the relevant accounting year. It is this view
of the High Court that is being challenged by the assessee company
in the Civil Appeal No. 860 of 1973 before us.
In Civil Appeal No. 1614/1978 (Ballarpur Industries Ltd) a1d
Review Petition No. 57 of 1980 (M/s. Bengal Paper Mills Co. Ltd.)
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[1982] 1 s.c.R.
'l\e are concerned with only two items of appropriation being (a)
provision for taxation and (b) provision for proposed dividend and
in each one of these cases the Calcutta High Court had taken the
view that these two items do not constitute "reserves" and as such
have to be ignored while computing the capital of the assessee
company.
In Tax Reference Case Nos. 2 and 3 of 1977 (M/s Echjay Industries Pvt. Ltd.)- a case under Companies (Profits) Surtax Act, 1964,
we are concerned with two items of appropriation being (a) provision
for taxation (b) provision for proposed dividend for the two assessment years 1969-70 and l 970-71 and in each of the years the Taxing
Authorities as also the Income Tax Appellate TribunalB ombay have
taken the view that these appropriations did not constitute "other
reserves" within the meaning of Rule I of the Second Schedule to
the Companies (Profit) Surtax Act, 1964 and as such were not
includible in the capital computation of the assessee company but in
view of a divergence of opinion between the different High Courts
on the point, the Tribunal has at the instance of the assessee
company made a direct Reference to this Court under s. 257 of the
Income Tax Act, 1961 read with s. 18 of the Companies (Profits)
Surtax Act, l %4.
In Tax Reference Case No. 5 of 1978 (Hyco Products Pvt.
Ltd.) -
also a case under Companies (Profits) Surtax Act, 1964 the
same question pertaining to dividend alone but in a different form
arose for consideration before the Taxing Anthorities and the Income
Tax Appellate Tribunal. It was not a case of 'proposed dividend'
but the assessee company after transferring Rs. 29,77,000 out of the
current year's profit amounting to Rs. 61,03,382 to General Reserves,
paid out of Rs. 3, I 0,450 as dividend to its share-holders from such
augmented General Reserves and the question was whether while
computing the capital of the assessee-company for the purpose of
levy of surtax the General Reserves should or should not be reduced
by the aforesaid sum of Rs. 3,10,450? In other words, the quesfion was whether the amount of Rs. 3,10,450 could not form part
of the General Reserves on the relevant date (being I.I. 1973) for
the computation of the capital ? The Taxing Authorities as well as
the Appellate Tribunal Bombay held that the said amount of
Rs. 3,10,450 had to be ignored for the purpose of computation of
capital for surtax purposes because it was not a reserve.
The
assessee company has challenged this view of the Tribunal before us
in this direct Reference made to this Court under s. 257 of the
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VAZIR SULTAN TOBACCO co. v. C.1.T. (Tulzapurkar, J.)
799
Income Tax Act, 1961 read with s. 18 of the Companies' (Profits)
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Surtax Act, 1964.
It may be stated that the scheme aud the main prov1S1ons of
the two concerned enactments are almost identical, the object of both
these enactments being the imposition of a special tax on excess profits
earned by companies. Under Section 4 of the 1963 Act, which is the
charging provision, there shall be charged on every company for every
assessment year commencing on and from !st April, 1963, a tax,
called the super profits tax, in respect of so much of its "chargeable
profits" of the previous year as exceed the "standard deduction" at
the rate or rates specified in the Third Schedule. Section 2(5) defines
the expression "chargeable profits" to mean the total income of an
assessee computed under the Income Tax Act, 1961, for any previous
year and adjusted in accordance with the provisions of First Schedule, while Section 2(9) defines the expression "standard deduction"
to mean an amount equal to six per cent of the capital of company as
computed in accordance with the provisions of the Second Schedule,
or an amount of Rs. 50,000 whichever is greater.
In order to
determine "standard deduction". it becomes necessary to compute
capital of the company in accordance with the rules laid down in the
Second Schedule and rule I is relevant for our purposes, the material
portion whereof runs as follows :
"I. Subject to the other prov1s10ns contained in this
Schedule, the capital of a company shall be the sum of
the amounts, as on the first day of the previous year
relevant to the assessment year, of its paid up share
capital and of its reserve, if any, credited under the
proviso (b) to Clause (vi-b) of sub-section (21 of sec.
JO of the Indian Income Tax Act, 1922 or under subsection (3) of sec. 34 of the Income Tax Act, 1961, and
of its other reserves in so far as the amounts credited
to such other reserves have not been allowed in computing its profits for the purposes of the Indian Income
Tax Act, 1922 or the Income Tax Act, 1961 ......... "
It will be clear from the aforesaid provision of rule l that
before any amount or sum qualifies for inclusio,1 in capital compu ·
tation of a company two conditions are required to be fulfilled-(a)
that the amount or sum must be a "reserve" and (b) the same must
not have been allowed in computing the company's profits for the
purposes of the 1922 Act or the 1961 Act.
That none of the items
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of appropriation either for taxation or for retirement gratuity, or
for proposed dividend in the concerned assessees' case had been
allowed in computing the assessee's profits under the 1961 Act has
not been disputed; in other words the second condition indicated
above has been satisfied. The question is whether any of these items
could be treated as or falls within the expression "other reserves"
occurring in the said rule.
The expression 'reserve' has not been defined in the Act and
therefore one would be inclined to resort to its ordinary natural
meaning as given in the dictionary but it seems to us that the
dictionary meaning, though useful in itself, may not be sufficient,
for, the dictionaries do not make any distinction between the two
concepts 'reserve' and 'provision' while giving their primary meanings whereas in the context of the legislation with which we are
concerned in the case a clear distinction between the two is implied.
According to the dictionaries (both Oxford and Webster) the applicable primary meaning of the word 'reserve' is : "to keep for future
use or enjoyment; to set apart for some purpose or end in view; to
keep in store for future or special use; to keep in reserve", while
'provision' according to Webster means : "something provided for
future." In other words according to the dictionary meanings both
the words are more or less synonymous and connote the same idea.
Since the rules for computation of capital contained in the Second
Schedule to the Act proceed on the basis of the formula of capital
plus reserves-a formula well-known in commercial accountancy, it
becomes essential to know the exact connotation of the two concepts
'reserve' and 'provision' and the distinction between the two as
known in commercial accountancy. Besides, though the expression
'reserve' is not defined in the Act, it cannot be forgotten that it
occurs in a taxing statute which is applicable to companies only and
to no other assessable entities and as such the expression will have
to be understood in its ordinary popular sense, that is to say, the
sense or meaning that is attributed to it by men of business, trade
and commerce and by persons interested in or dealing with companies.
Therefore, the meanings attached to these two words in
the provisions of the Companies Act 1956 dealing with preparation
of balance-sheet and profit and loss account would govern their
construction for the purposes of the two taxing enactments. We
might mention here that in C.I.T. v. Century Spinning and Manufacturing Company(') this Court after referring to the dictionary
(J) 24 I.T.R. 499.
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VAZIR SULTAN TOBACCO co. v. C.l.T. (Tultapurkar, J.)
801
meaning of the expression 'reserve' observed : "what is the true
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nature and character of the disputed sum (sum allegedly set apart)
must be determined with reference to the substance of the matter"
and went on to determine the true nature and character of the disputed sum by relying upon the provisions of the Indian Companies Act
1913, the form and the contents of the balance-sheets required to be
drawn up and Regulation 99 in Table A of the I st Schedule ..
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The distinction between the two concepts of 'reserve' and
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'provision' is fairly well-known in commercial accountancy and the
same has been explained by this Court in Metal Box Company of
India Ltd. v. Their Workmen (1) thus :
"The distinction between a provmon and a reserve
is in commercial accountancy fairly well known.
Provisions made against anticipated losses and contigencies are
charges against profits and therefore, to be taken into
account against gross receipts in the P. and L. 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 balancesheet 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 proprietor's interest.
(See
Spicer and Pegler's
Book-keeping and Accounts, 15th
Edition, page 42)".
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 P and L 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.
Under s. 210 of the Companies Act, 1956 it is incumbent
upon the Board of Directors of every company to Jay before the
annual general meeting of its share-holders (a) the annual balancesheet and (b) the profits and Joss account pertaining to the previous
(I) 73 I.T.R. 67.
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SUPREME COURT REPORTS
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financial year. Section 211(1) provides that every balance-sheet of
a company shall give a true and fair view of the state of affairs of
the company as at the end of the financial year and shall, subject to
the provisions of this section, be in the form set out in Part I of
Schedule VI, or near thereto as circumstances admit or in such other
from as may be approved by the Central Government either generally or in any particular case, while s. 211(2) provides that every
profit and loss account of a company shall give a true and fair view
of the profit or loss of the company for the financial year and shall,
subject as aforesaid, comply with the requirements of Part II of
Schedule VI, so far as they are applicable thereto.
In other words
the preparation of balance-sheet as well as profit and loss account
in the prescribed forms and laying the same before the share-holders
at the annual general meeting are statutory requirements which the
company has to observe.
The Form of balance·sheet as given in
Part I of Schedule VI contains separate heads of 'reserves and
surpluses' and 'current liabilities and provisions' and under the
sub-head 'reserves' d,ifferent kinds of reserves are indicated and
under sub-head 'provisions' different types of provisions are indicated; Part III is the interpretation clause setting out the definitions
of various expressions occurring in Parts I and II and the expressions
'reserve', 'provision' and 'liability' have been defined in cl. 7 thereof.
Material portion of cl. (7) of Part III runs as under :
"(l) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires :
(a) the expression "provision" shall, subject to sub·
cl. (2) of this clause mean any amount written off
or retained by way of providing for depreciation,
renewals or diminution in value of assets, or retained by way of providing for any known liability
of which the amount cannot be determined with
substantial accuracy;
(b) the expression "reserve" shall not, subject as
aforesaid, include any amount written off or
retained by way of providing for depreciation,
renewals or diminution in value of assets or retained by way of providing for any known liability;
(c)
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VAZIR SULTAN TOBACCO co. v. c.I.T. (Tulzapurkar, J.)
803
and in this sub-clause the expression "liability" shall include
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all liabilities in respect of expenditure contracted for and
all disputed or contingent liabilities.
(2)
Where--
(a) any amount written off or retained by way of
providing for depreciation, renewals or diminution
in value of assets, not being an amount written off
in relation to fixed assets before the commencement of this Act; or
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(b) any amount retained by way of providing for any
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known liability;
is in excess of the amount which, in the opmion of the
directors, is reasonably necessary for the purpose, the
excess shall be treated for the purposes of this Schedule as
a 'reserve' and not a 'provision'."
On a plain reading of cl. 7(1) (a) and (b) and cl. 7(2) above it
will appear clear that though the term 'provision' is defined positively
by specifying what it means the definition of 'reserve' is negative in
form and not exhaustive in the sense that it only specifies certain
amounts which are not to be included in the term 'reserve'. In
other words the effect of reading the two definitions together is that
if any retention or appropriation of a sum falls within the definition
of 'provision' it can never be a reserve but it does not follow that
if the retention or appropriation is not a provision it is automatically a reserve and the question will have to be decided having
regard to the true nature and character of the sum so retained or
appropriated depending on several factors including the intention
with which and the purpose for which such retention or appropriation has been made because the substance of the matter is to be
regarded and in this context the primary dictionary meaning of the
term 'reserve' may have to be availed of. But it is clear beyond
doubt that if any retention or appreciation of a sum is not a provision, that is to say, if it is not designated to meet depreciation,
renewals or diminution in value of assets or any known liability the
same is not necessarily a reserve.
We are emphasising this aspect
of the matter because during the hearing almost all counsel for the
assessees strenuously contended before us that once it was shown
or became clear that the retention or appreciation of a sum out of
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profits and surpluses was for an unknown liability or for a liability
which did not exist on the relevant date it must be regarded as a
reserve. The fallacy underlying the contention becomes apparent
if the negative and non-exhaustive aspects of the definition .of reserve
are borne in mind. Having regard to type of definitions of the
two concepts which are to be found in cl. 7 of Part.