Case Note & Summary
The appeal arose from a reference made by the Income-tax Appellate Tribunal to the Calcutta High Court under Section 256(1) of the Income-tax Act, 1961, concerning the computation of capital under the Super Profits Tax Act, 1963 and the Companies (Profits) Surtax Act, 1964 for assessment years 1963-64 and 1964-65. The assessee, a company, had made provisions for taxation of Rs.16,48,888 and Rs.17,52,920 respectively in its accounts for the two assessment years. The assessing officer disallowed the assessee's claim that these provisions should be treated as part of capital or alternatively deducted from the cost of investments whose income was excluded from chargeable profits. The Appellate Assistant Commissioner partially allowed the claim by accepting the alternative contention that the provision should be deducted from the cost of investments. The Income-tax Appellate Tribunal, however, held that the provision for taxation was not a reserve, fund, or surplus, as it was a provision against a perfected debt, and disallowed any deduction. On reference, the Calcutta High Court answered the first question in favour of the revenue, holding that the provision was not a reserve, but answered the remaining questions in favour of the assessee, permitting deduction. The revenue appealed to the Supreme Court. The Supreme Court framed the only issue as whether the provision for taxation could be deducted from the cost of excluded investments to augment the capital base under the Second Schedules of the two Acts. The Court noted that under both Acts, tax is levied on chargeable profits exceeding a statutory deduction computed as a percentage of capital, and capital is computed as per the Second Schedules. Rule 1 of the Second Schedule to the Super Profits Tax Act, 1963 and Rule 2 of the Second Schedule to the Companies (Profits) Surtax Act, 1964 allowed cost of excluded assets to be reduced by 'any fund, any surplus and any such reserve as is not to be taken into account in computing the capital'. The assessee relied on this clause. The Court, following Vazir Sultan Tobacco Co. Ltd. v. Commissioner of Income Tax, held that a provision for current tax liability cannot be a reserve. It then examined whether it could be a fund. Interpreting the terms in accounting parlance and in light of Schedule VI to the Companies Act, 1956, the Court observed that the note to 'reserves and surplus' requires the word 'fund' to be used only where a reserve is specifically represented by earmarked investments. The dictionary definition of 'fund' also required an asset or group of assets separated physically or in accounts for specific uses. In the present case, there was no systematic accumulation of cash or separation of assets; there was only an accounting entry earmarking an exact sum for payment of tax liability at the end of the year. Hence, the provision could not be considered a fund. The CBDT circular regarding 'reserve for unexpired risks' was held inapplicable. Accordingly, the Supreme Court allowed the revenue's appeal, reversed the High Court's decision on the deduction issue, and held that the provision for taxation could not be deducted from the cost of investments.
Headnote
A) Taxation - Super Profits Tax and Surtax - Computation of Capital - Deduction of Provision for Taxation - Super Profits Tax Act, 1963, Second Schedule, Rule 1, Clause (ii); Companies (Profits) Surtax Act, 1964, Second Schedule, Rule 2, Clause (ii) - The assessee claimed that the provision for taxation should be deducted from the cost of excluded investments while computing the capital base; the High Court allowed the deduction, but the Supreme Court held that clause (ii) permits deduction only for 'fund', 'surplus', or 'reserve', and a provision for taxation is not a fund because it is not represented by earmarked investments or systematic accumulation of assets; it is merely an accounting entry for current tax liability; therefore the provision could not be deducted and the revenue's appeal was allowed. Held that provision for taxation cannot augment capital under the Second Schedules. (Paras 1-7) B) Interpretation - Accounting Terminology - Meaning of 'Fund' - Companies Act, 1956, Schedule VI - The terms 'fund', 'surplus', and 'reserve' in the Second Schedules must be interpreted in light of balance sheet and accounting practice; Schedule VI note indicates 'fund' used only when a reserve is specifically represented by earmarked investments; dictionary definition requires an asset group separated for specific uses; a mere book entry for tax liability lacks such characteristics; hence it is not a fund under clause (ii). Held that accounting entry alone insufficient to constitute fund. (Paras 1-7) C) Precedent - Reserve - Provision for taxation - Vazir Sultan Tobacco Co. Ltd. v. Commissioner of Income Tax, (1981) 132 ITR 559 - A provision made to meet tax liability of current accounting year cannot be considered as representing a reserve; this principle was accepted and not disputed before Supreme Court. Held that provision not reserve. (Paras 1-7)
Issue of Consideration
Whether the provision for taxation can be deducted from the cost of excluded investments and thereby augment the capital base of the company for the purposes of the Super Profits Tax Act, 1963 and the Companies (Profits) Surtax Act, 1964
Final Decision
The Supreme Court allowed the revenue's appeal, holding that the provision for taxation could not be considered a fund or surplus and therefore could not be deducted from the cost of excluded investments while computing capital under the Super Profits Tax Act, 1963 and the Companies (Profits) Surtax Act, 1964; the High Court's decision on the deduction issue was reversed, and the questions were answered in favour of the revenue.
Law Points
- Provision for taxation is not a reserve
- fund
- or surplus under the Second Schedules of the Super Profits Tax Act
- 1963 and Companies (Profits) Surtax Act
- 1964
- terms in the Second Schedule must be interpreted in accounting parlance
- a fund requires systematic accumulation or earmarked investments
- not a mere accounting entry
- deduction from cost of excluded investments under clause (ii) of Rule 1 of the Second Schedule to Super Profits Tax Act
- 1963 and clause (ii) of Rule 2 of the Second Schedule to Companies (Profits) Surtax Act
- 1964 is not available for provision for taxation
