Case Note & Summary
The First National City Bank, a non-resident bank incorporated under the National Bank Act of the United States of America with its head office in America and branches in India, was assessed under the Business Profits Tax Act, 1947 for four chargeable accounting periods between April 1, 1946 and March 31, 1949. The sole question was the meaning of the word 'reserves' in Rule 2(1) of Schedule II of the Act and how the bank's capital should be computed for allowing abatement. The appellant contended that the amount shown in its balance sheets as 'Undivided Profits' fell within the meaning of 'reserves'. For illustration, as on December 31, 1946, the balance sheet showed capital of $77,500,000, surplus of $152,500,000, and undivided profits of $29,534,614.21. The Directors' Report dated January 14, 1947 indicated that surplus had increased by transfer of $10,000,000 from undivided profits, and the total capital funds, including capital, surplus, and undivided profits, had increased. Under the Treasury Rules of the United States and Instructions for Preparation of Reports of Condition by National Banking Associations, certain sums had to be specifically allocated under Section 5211 of the Revised Statutes, and the appellant was required to keep a sum under the head 'undivided profits' as an integral part of the capital structure. Losses, according to practice, could be charged against undivided profits, i.e., profits set apart after provision for expenses and taxes for continuous use in the business. The Income-tax Officer and the Appellate Assistant Commissioner excluded the undivided profits from capital computation on the ground that they were not part of reserves. The Income-tax Appellate Tribunal dismissed the appeal, holding that undivided profits meant nothing more than balance of the profit and loss account. The High Court, applying the test from Century Spinning & Manufacturing Co. Ltd. v. C.I.T., Bombay, held that undivided profits did not constitute reserves because no direction had been given, no transfer to any reserve had been made, no earmarking for any particular purpose, and no act of volition on the part of the directors existed. On appeal, the Supreme Court reversed. It noted that the Directors' Report evidenced a positive act: the directors increased surplus by $10,000,000 taken from undivided profits and left a specific sum in undivided profits, resulting in an increase in per share capital funds from $44.60 to $46.39. This allocation and retention of undivided profits satisfied the requirement of an act of volition. The Court held that the amount designated as 'undivided profits' was part of reserves and had to be taken into account when computing capital and reserves within Rule 2(1) of Schedule II of the Business Profits Tax Act, 1947. The appeal was allowed and the High Court judgment was set aside.
Headnote
A) Business Profits Tax - Reserves - Undivided Profits - Business Profits Tax Act, 1947, Schedule II Rule 2(1) - The issue was whether undivided profits of a non-resident banking company are reserves for computing capital and abatement. The Income-tax Officer, Appellate Assistant Commissioner, Tribunal, and High Court excluded the amount on the ground that undivided profits were analogous to balance of profit and loss account lacking an act of volition. The Supreme Court held that under US Treasury Rules, undivided profits had to be specifically allocated under Section 5211 of the Revised Statutes of the United States, formed an integral part of capital structure, and were available for continuous use in business; the directors' allocation of surplus and retention of undivided profits constituted sufficient act of volition. Held that undivided profits are part of reserves and must be included in capital and reserves under Rule 2(1) (Paras not mentioned).
Issue of Consideration
Whether the sum shown as 'Undivided Profits' in the balance sheet of a non-resident bank constitutes 'reserves' within Rule 2(1) of Schedule II of the Business Profits Tax Act, 1947, entitling inclusion in capital for abatement.
Final Decision
The Supreme Court allowed the appeal, held that the amount designated as 'undivided profits' was a part of the reserves, and had to be taken into account when computing capital and reserves within Rule 2(1) of Schedule II of the Business Profits Tax Act, 1947. The judgment of the Bombay High Court was set aside.
Law Points
- Undivided profits of a non-resident banking company are part of reserves under Rule 2(1) Schedule II Business Profits Tax Act
- 1947
- 'Reserves' includes amounts allocated from profits for continuous use in business even if not transferred to a separate reserve account
- Act of volition evidenced by directors' allocation of surplus and retention of undivided profits suffices
- Balance sheet nomenclature is not conclusive
- Capital and reserves for abatement include undivided profits not allowed in computing profits under the Indian Income-tax Act
- 1922
