Holding

All the reserves except the obsolescence reserve and the forfeited moneys reserve are to be treated as "other reserves" and included in the computation of capital under the Second Schedule of the Super Profits Tax Act, 1963.

Summary

The Supreme Court examined whether various reserves created by Saran Engineering Co. Ltd. could be treated as "standard deductions" under the Super Profits Tax Act, 1963, and thus be included in the computation of capital for the Companies (Profit) Surtax Act, 1964. The reserves in question included capital reserve, stocks and stores reserve, bad and doubtful debts reserve, loans and insurance reserve, investment reserve, rehabilitation reserve, obsolescence reserve and forfeited moneys reserve. The Court held that, except for the obsolescence reserve and the forfeited moneys reserve, all the other reserves qualify as "other reserves" under Rule 1 of the Second Schedule and must be included in the capital computation. It clarified that a fund created to meet a liability that has not yet arisen is still a reserve for capital‑computation purposes. The High Court’s partial rulings in favour of the revenue were affirmed, and the Special Leave Petition was dismissed. Consequently, the appeals were allowed only in part, with the remaining claims rejected.

Issues considered

Whether capital reserve, stocks and stores reserve, bad and doubtful debts reserve, loans and insurance reserve, investment reserve, rehabilitation reserve, obsolescence reserve and forfeited moneys reserve are to be included in the computation of capital under the Second Schedule of the Super Profits Tax Act, 1963.
Whether reserves created for anticipated liabilities but not for specific existing liabilities qualify as "other reserves" within the meaning of Rule 1 of the Second Schedule of the Companies (Profit) Surtax Act, 1964.
Whether the High Court and Tribunal were correct in their respective determinations regarding the inclusion or exclusion of the aforesaid reserves.

Legislation cited

Companies (Profit) Surtax Act, 1964s. Rule 1, s. Second Schedule
Income Tax Act, 1961s. Section 256(2)
Super Profits Tax Act, 1963s. Second Schedule, s. Section 2(a), s. Section 4

Subjects

capital reservestandard deductionSuper Profits Tax ActCompanies (Profit) Surtax Actreserve classificationincome taxcapital computationcase law

Judgment

A

COMMISSIONER OF INCOME TAX, KANPUR
v.
SARAN ENGINEERING CO. LTD.
B
JULY 31, 1986

[R.S. PATHAK AND SABYASACHI MUKHARJI, JJ.J

Computation of capital-Super Profits Tax Act, 1963, Second
Schedule-Whether capital reserve, stock and stores Reserves, Bad and
c . doubtful debts reserves, Rehabilitation Reserve, Obsolescence reserve,
Loans and Insurance reserve, Investment reserve and Forfeited moneys
reserves are to be included in the computation of capital reserve.

Company (Profits) Surtax Act, 1964, Rule (/) of the Second
D Schedule-Computation of the company law made-Whether the
Gratuity Reserve, Reserve for Special Survey, Reserve for contingen-
cies, Fleet Replacement Reserve, Reserve for exempted profits under
section 84 of the Income Tax, Reserve for investment depreciation and
Dividend Equalisation Reserve etc. are includible.

E The assessee, in CA 1546 of 1974, M/s British India Corporation
Ltd. claimed capital Reserve, Stocks and Stores Reserves, Bad and
doubtful debts Reserves, Obsolescence reserve, Loans and Insurance
reserve, investment reserve and forfeited moneys reserves as ''standard
deduction" as defined in section 2(a) of the Super Profits Tax Act, 1963
in the computation of its profits under the relevant Income Tax Act.
F The claim having been disallowed, the question has been referred to this
Court by the Tribunal.

In Civil Appeal No. 1599/74 the Saran Engineering Company Ltd.
claimed similar deductions in respect of capital reserve, Rehabilitation
Reserve, Stores Reserve forfeited moneys Reserve and Bad and doubt-
G ful debts reserve. The Income Tax Officer rejected the claim. On appeal
the Appellate Assistant Commissioner allowed the claim in part. The
Tribunal however allowed the assessee's claim in full in further appeal
while rejecting the Revenue's appeal against A.A.C's order. At the
instance of the Revenue, the Tribunal referred the matter to the High
Court. The High Court answered the reference partly in favour of the
H Revenue by negativin~ th1• daim as to forfeited moneys reserve and
398
C.I.T. v. SARANENGIN. CO. 399

restricting the quantum of amount allowed by the AAC regarding capi- A
tal reserve, as the assessee did not seek a reference against it. Hence the
appeal by Revenue by Special Leave.

In the Special Leave Petition No. SLP (C) 4815A/77 the High
Court's rejection order of the revenue's request under section 256(2)
B
for calling for a case against the Tribunal's findings regarding the.

~
Gratuity Reserve, Reserve for Sepcial Survey, Reserve for contingen-
cies, fleet Replacement reserve, Reserve for exempted Profits under
section 84 of the Income Tax Act, Reserve for Investment depreciation
~ and Dividend Equalisation Reserve but allowing only in relation to the
Reserve for special Survey come to be considered.
c
Allowing the two civil appeals in part and dismissing the Special
Leave Petition, the Court
)---

HELD: 1. In the facts and circumstances of the case, except the
D
obsolescence Reserve and the forfeited moneys reserve, all the Reser-
ves, namely, capital Reserve, Stocks and Stores Reserve, Bad and
doubtful debts reserves, Loans and Insurance Reserve, Investment re-
serve, and rehabilitation reserve are to be included in the computation
of capital according to the provisions in the Second Schedule to the
Super Profits Tax Act, 1963.
E
2. Where the liability bas actually arisen or anticipated Iegiti-

,
~
mately by the assessee though the quantum of the liability has not been
determined, to meet such present liability cannot be treated as"'re-
serve". A fund, however, created for payment of a liability which had
not already arisen or fallen due but orly a provision with regard to the
sum that might become liable to be paid is "other reserve within the
meaning of rule ( l) of second schedule and should be taken into acoount
F

in computing the capital of the company for the purpose of the Com-
panies (Profit) Surtax Act, 1964. Except the item relating to Reserve for
special survey, it is not necessary to call for any statement of the case in
respect of other items in SLP (C) 4815/./77. [406G-H; 407A]
G
Commissioner of Income Tax, Kanpur v. The Elgin Mills Ltd.,
Kanpur, [1986] 3 SCR P. 408, followed.

CIVIL APPELLATE JURISDICTION: Civil Appeal No. 1599
of 1974
H
400 SUPREME COURT REPORTS 11986] 3 S.C.R.

A From the Judgment and Order dated 19.7.1973 of the Allahabad
High Court in I.T. Reference No. 200 of 1971.

and

B Civil Appeal No. 1546 of 1974

From the Judgment and Order dated 21.7.1972 of the Allahabad
High Court in I.T. Reference No. 172of1971.
S.L.P. No. 4815A of with 1977 "
B.H. Ahuja for the Appellant in C.A.No. J599of 1974.
C Dalip Singh, Ms. A. Subhashini and K.C. Dua for the Appellant
in C.A. No. 1546 of 1974 and S.L.P. No. 4815A of 1977.

Harish Salve, K.J. John, Ranjit Kumar and B.P. Singh for the
Respondents.
D
The Judgment of the Court was delivered by

SABYASACHI MUKHARJI, J. In Civil Appeal No. 1546 of
1974 the following items were involved: (a) Capital Reserve (b) Stocks
and stores reserves, (c) Bad and doubtful debts reserves, (d) Obsolesc-
ence reserve, (e) Loans and Insurance reserve (f) Investment reserve
E
and (g) Forfeited moneys reserves. The question was whether these

.
were to be included in the computation of capital according to the
provisions in the second schedule to the
.
Super Profits Tax Act, 1963.

Under Section 4 of the Super Profits Tax Act, 1963, every com-
F pany shall be charged for every assessment year commencing from 1st
April, 1963 a tax as Super Profits tax in respect of so much of its
chargeable profit of the previous year as exceed the standard deduc-
tions at the rate or rates specified in the third schedule. 'Standard
deduction' had been defined in clause (9) of section 2 as follows:

"An amount equal to six per cent of the capital of the
G
company as computed in accordance with the provisions of
the second schedule; on an amount of Rs.50,000 whicccver
is greater.''

The second schedule contained rules for computation of capital
H of a company for the purpose of the said Act.
C.I.T. v. SARANENGIN.CO. (MUKHARJl,J.( 401

None of the reserves claimed by the assessee had been allowed as A
deductions in the computation of its profits under the relevant Income-
tax Act. The question was whether these represented reserves.

The Tribunal has referred to this Court the following question:
B
"Whether, on the facts and in the circumstances of the
case, the Tribunal was right in holding that: (ii) Capital
Reserve, (b) Stocks and stores reserves, (c) Bad and
Doubtful debts reserve (d)Obsolescence reserve, (e) Loans
• and Insurance reserves, (f) Investment reserve and (g)
Forteited moneys reserves were to be included in the com-
putation of capital according to the provisions in the second c
schedule to the Super Profits Tax Act, 1963?"

We must observe that so far as the capital reserves are con-
cerned, in view of the findings recorded by the High Court that the
amount represented reserve and it was not ear-marked for any existing D
liability for being utilised by the company, it must be held to be
reserve.

The capital reserve which was a sum of Rs.11,73,952 consisted of
two amounts namely Rs.12,212 and Rs.11,61,770. The amount of
Rs.12,212 represented an insurance claim received by the assessee
E
company on account of a fire which had destroyed some assets of the
assessee company. The said receipt of fire insurance claim has directly
been credited to the capital account and the sum of Rs.11,61, 770 was
credited by transfer from the Profit & Loss Account in the earlier
years. This was not provided for against any existing or future liability.
It was rightly treated as capital reserve.
F
The next item was Stocks and Stores Reserve. This was created
in 1950 by transfer from the Profit and Loss Appropriation Account.
This did not represent any existing provision for existing liability to
meet any specific contingency for safeguarding against diminution of
the value of the stocks and stores. It was in the nature of a reserve for
G
safeguarding against any possible diminution of the value of stocks and
stores on any future occasion. In our opinion, the Tribunal was right in
treating it as reserve.

Bad and Doubtful Debts Reserve was created in 1956 through
the Profit and Loss Appropriation Account. The amount involved was H
402 SUPREME COURT REPORTS [1986] 3 S.C.R.

A Rs.5,00,000. It was submitted on behalf of the assessee by Shri Salve
that this was created by transfer from the Appropriation Account and
not a charge against profit. Furthermore, a separate provision was
made for bad and doubtful debts which provision was reduced from
the value of the assets. It was not the revenue's case that the provision
for bad and doubtful debts provided was less than the amount reason-
B ably necessary to be provided. If the amount as it appears to be is more
than the amount reasonably necessary to be provided in respect of bad and
doubtful debts then it constituted a 'reserve'. It is not correct to state
that by very nomenclature this was not a reserve. True nature of the
transaction has to be examined.

c The next item is Obsolescence Reserve of Rs. l,72,259. This was
created in 1959 by transferring a sum of Rs.12,05,000 from the Profit
and Loss Account. Some amounts were written off out of this reserve in
1960 and 1961. This appears to be provision to meet future liability and
contingency. But there are not much facts about it. Had it been neces-
sary we might have remanded the matter to the High Court to direct
D the Tribunal to find facts on this aspect. But as in that view of the
matter, this item was not pressed before us, so this item is deleted from
reserve of the assessee.

So far as Loan and Insurance Reserve is concerned, this was
created prior to 1947. It was found that it was free from any burden
E and it was not utilised for any purpose and was transferred to the
General Reserve Account in 1963. Therefore, it was rightly treated, in
view of the principles mentioned hereinbefore as reserve.

The next item is Investment Reserve. This fund was created out
of the surplus on the sale of investment which was not held by the
F respondent company as its stock in trade. The surplus did not have its
origin in business profits and was transferred directly to the reserve
account but this was created prior to 1954 and was further credited in
1955 to 1957 out of the profits on sale of investments. In the later
years, whenever a loss of a capital nature was incurred it was debited
to this account. It appears that at the time of creating this Reserve, the
G Directors could not have possibly anticipated the losses which might
occur in future but merely created a reserve so that losses which do
normally arise in the course of business might be adjusted against this
amount. It appears therefore that this was a reserve created out of the
capital profit. This reserve can rightly be treated as other reserves.
H Forfeited moneys reserve, in our opinion, cannot be treated as
C.LT. v. SARANENGIN. CO. [MUKHARJI,J.) 403

reserve, and the High Court has also not treated it as such. In that view A
of the matter except the item indicated as Obsokscence Reserve which
is deleted from the reserve as indicated before, we uphold the order of
the High Court. This appeal is dismissed subject to the extent indi-
cated above. There will be no order as to costs.
B
In Civil Appeal No. 1599 of 1974, the following facts were
recorded:

"The assessee is a limited company. In proceedings under
the Super Profit Tax Act, 1963, the assessee claimed that
the following amounts appearing as credit balances in the

'
various accounts mentioned against each be treated as re- C
serves and included in the capital of the company for the
purposes of determining the standard deductions, as con-
templated under section 2(9) of the Act:

(a) Capital reserve Rs.9,41,488
D
{b) Rehabilitation reserve Rs.6,00,000
(c) Stores reserve Rs. 75,000
{d) Forfeited moneys reserve Rs. 8,000
(e) Bad and doubtful debts reserve Rs. 25,000
E
The Income-tax Officer rejected the assessee's claim. On appeal
the Appellate Assistant Commissioner allowed the claim of the asses-
see in part. The revenue and the assessee both went up in appeal
before the Tribunal. The Tribunal had allowed the claim of the asses-
4 see in full. The revenue feeling aggrieved referred the following ques-
' F
tion to the High Court:

"Whether, on the facts and in the circumstances of the
case, the Tribunal was right in holding that:

(a) Capital reserve
G
{b) Rehabilitation reserve,
(c) Stores Reserve
{d) Forfeited moneys reserve; and
(e) Bad and doubtful debts reserve,
H
>·
''

404 SUPREME COURT REPORTS 11986] 3 S.C.R.

A were to be included in computation of capital according to _...
the provisions of the second Schedule to the Supper Profits-
Tax Act (Surtax) 1963."

So far as the capital reserve is concerned, in the light of discus-
sion in Civil Appeal No. 1665 of 1974-CIT, Kanpur v. The Elgin Mills
'
B
Ltd., Kanpur (Infra p. 408) and also in Civil Appeal No. 1546 of 1974-
CIT, Kanpur v. Mis British India C01poration Ltd., the High Court was
right in treating this account as reserve. It must be further noted that so f
far as capital reserve was concerned, the Appellate Commissioner had
allowed a sum of Rs.7,19,488 out of a claim of Rs.9,41,488. In appeal,
the Tribunal upheld the order of the Appellate Commissioner. The
J. ·-
c assessee did not seek a reference against this in the High Court. The
controversy before the High Court was confined to the claim allowed by
the Appellate Commissioner. The High Court held in favour of the
1
assessee in treating it a reserve. The High Court was right.
'i
So far as the rehabilitation reserve and stores reserve are con-
·ii'
D
cerned, in view of the facts found by the Tribunal and in the light of the
reasons indicated in Civil Appeal No. 1546 of 1974, in our opinion, this
must be treated as reserve as was held by the Tribunal.

The High Court has disallowed the forfeited money reserve to be
E
treated as reserve. We are of the opinion that the High Court was
right.

So far as Bad and Doubtful Debts are concerned, in the light of
the observations made in Civil Appeal No. 1546 of 1974 and in the

'
light of the facts found, this must be treated as reserve.
.F
In the aforesaid view of the matter, the appeal fails and is accord-
ingly dismissed. In the facts and circumstances of the case, there is no :;
order as to costs.

Special Leave Petition No. 4815A of 1977 arises out of the deci- ,.
G sion of the Bombay High Court where the High Court rejected the
application under section 256(2) of the Income-tax Act, 1961, for an
order directing the Income-tax Appellate Tribunal, Bombay to state a
case in relation to the various items specified in the question. The
question was as follows: i.-~·

H "Whether, on the facts and in the circumstances of the
C.I.T. v. SARANENGIN. CO. [MUKHARJI,J.) 405

case, the Tribunal was right in holding that Gratuity A
Reserve of Rs.2,00,000, Reserve for Special Survey of
Rs.13,04,600, Reserve for Contingencies of Rs.56,00,000.
Fleet Replacement Reserve of Rs.54,35,250, Reserve for
exempted profits under section 84 of Rs.1,64,900, Reserve
for Investment depreciation of Rs. 7,09,144 and Dividend B
Equalisation Reserve of Rs.2,00,000 were reserves with the
meaning of the Second Schedule to the Act?"

The Tribunal by its order dated 21st July, 1976, rejected this
~· application as one of fact and the principles not being in dispute.

r The revenue thereafter applied to the High Court under section
256(2) of the Act read with section 18 of the Companies (Profits)
Surtax Act, 1964. By its order dated 20th June, 1977, the Bombay
c

High Court allowed the application only in relation to the Reserve for
Special Survey for Rs.13,04,600 and rejected the application so far as
other items are concerned. D
Being aggrieved, the assessee has come in Special Leave Peti-
tion. The facts regarding the same as found by the Tribunal are as
follows:

"(i) The Gratuity Reserve of Rs.2,00,000 was created for
E
the first time during the preceding year. The amount was
not claimed as revenue expenditure. Some payments were
acutally paid during the preceding accounting year. The
amount was to be included in the capital base as "other
Reserves".
F
(ii) Reserve for Special Survey: Rs.13,04,600: The balance
in this reserve account on the first day of the preceding
accounting year was Rs.9,32,500 to which was added Rs.15
lakhs by transfer from the Profits and Loss Account making
a total of Rs.24,32, 500. During that preceding year ex-
penses of Rs.11,26,900 were incurred and debited to this
G
reserve and the balance of Rs.13,04,600 was carried for-
ward. This amount was to be included in the capital base.

(iii) Reserve for contingencies: Rs.56,00,000: This reserve
account was meant to be utilised in case of contingencies
and there was no specific liability for spending even a part H
406 SUPREME COURT REPORTS [1986) 3 S.C.R.

A of this amount on the first day of the accounting year and it
was therefore includible in the capital base.

(iv) Fleet replacement reserve: Rs.54,35,250: This reserve
was like the reserve for contingencies._Here also there was
B no liability in pre sen ti towards purchase of any vessel on
the first day of the accounting year and this sum also was
includible in the capital base.

(v) Reserve for exampled profits under section 84 of the
Income-tax Act: Rs.1,64,900: This was not meant for meet- J
ing any liability and had therefore to be included in the
c capital base. 1
(vi) Reserve for investment depreciation: Rs.7,09,144: This
reserve was created originally in order to cushion the effect
of fluctuations in the prices of foreign securities held by the
assessee. This amount was ultimately transferred in 1971 to
0
the Profits and Loss Appropriation Account. Here also the
reserve was not created by way of making provision for
liability already accrued on or before the first day of the
accounting year and had therefore to be included in the
capital base.
E
(vii) Dividend Equalisation Reserve: Rs.2,00,000: This re-
serve was set apart to enable the assessee to declare reason-

F
able dividend in a year in which the profit was likely to go
down. This amount was subsequently transferred to the
General Reserve in 1971. This amount was also to be inc-
luded in the capital base."
-
In view of the facts as recorded by the Tribunal and in the light of
the principles settled by various decisions and reiterated by this Court
in Civil Appeal No. 1665 of 1974, (supra) it is not necessary to call for
any statement of the case and the High Court was right. It may be
mentioned that where the liability has actually arisen or anticipated
G
legitimately by the assessee though the quantum of the liability has not
been determined, to meet such present liability cannot be treated as
'reserve'. A fund, however, created for payment of a liability which
had not already arisen or fallen due but only a provision with regard to
the sum that might become liable to be paid is 'other reserve within the
H meaning of rule (1) of second schedule and should be taken into ac-
C.I.T. v. SARANENGIN. CO. [MUKHARJI,J.] 407

count in computing the capital of the company for the purpose of the A
Companies (Profit) Surtax Act, 1964.

In that view of the matter, we are of the opinion that the decision
of the High Court was right. The principles applicable in these types of
cases have been discussed by this Court in several decisions. It is not
B
necessary to reiterate these again.

In the premises this application fails and is accordingly dismis-
sed. In the facts of this case, parties will pay and bear their own costs.

S.R. Appeals allowed in part.