Al Wakeelo
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Your Digital Lawyer, Always on Duty
Initializing Secure Chambers
Petitioner: COMMISSIONER OF INCOME-TAX AND BUSINESS PROFITS TAX, MADRAS VS Respondent: VASANTHA MILLS LTD.Honorable Justice RAJAGOPALANT. V. Viswanatha lyer and, S. Narayanaswami,C. S. Rama Rao Sahib
1966 P T D 567
1966 P T D 567
[Madras (India)]
Before Rajagopalan and Rajagopala Ayyangar, JJ
COMMISSIONER OF INCOME‑TAX AND BUSINESS PROFITS TAX, MADRAS
versus
VASANTHA MILLS LTD.
Case Referred No. .96 of 1953, decided on 20th March 1957.
Business Profits Tax Act, 1947, Sch. II, rule 2(1)(a) Company‑Computation of capital for purposes of abatement Reserves‑Necessity for allocation of reserves before first day of chargeable accounting period‑Allocation by directors possessing requisite authority‑ Validity "Reserves", meaning of‑Alloca tion of amount for payment of tax; whether "reserve"‑‑Indian Companies Act (VII of 1913), S. 131‑A (1).
In the balance‑sheet of the assessee‑company for the calendar year .1945, a sum of Rs. 2 lakhs was shown as appropriated to the reserve account and a sum of Rs. 9 lakhs was shown as reserve for the payment of income‑tax and excess profits tax. This allocation was made by a resolution of the board of directors at a meeting held on March 15, 1946, and the shareholders' meeting to consider the directors' report was held on April 15, 1946. The articles of association of the company gave an absolute discretion to the directors to allocate sums of money to the reserves before they recommended a dividend. For the chargeable accounting period 1st April 1946 to 31st December 1946, the assessee company claimed that in computing its capital, for the purposes of abatement under rule 2 (1) of Schedule II to the Business Profits Tax Act, these two sums should be included in the reserves
Held, (i) that
there was a valid and effective allocation of the two sums to the reserves before the material date, namely, 1st April, 1946; the allocation made by the directors, who alone were entitled under the articles of the company to so allocate, was valid and effective on 15th March 1946; and the fact that the shareholders purported to ratify later what the directors had already done did not affect the validity or the effectiveness of that allocation; and
(ii) that the allocation of the sum of Rs. 9 lakhs to be set apart for utilisation towards the payment of tax was a "reserve" within the meaning of rule 2 (1).
With respect to the year of account 1946, the meeting of the board of directors at which an allocation to the reserves was made, was held on April 15, 1947, and the shareholders' meeting to consider the report of the board of directors was held on May 14, 1947. The company similarly claimed that with respect to the chargeable accounting period commencing on 1st April 1947, the amount allocated to reserves should be taken into account:
Held, that, as the factual appropriation was made only after 1st April 1947, and the appropriation could not be related back to 31st December 1946, though the final balance‑sheet for that year showed an appropriation effective from that day, the funds of the company available to it on 1st April 1947, constituted only a mass of undistributed profits and no portion of such undistributed profits could be reserved.
What rule 2(1)(a) of Schedule II to the Business Profits Tax Act requires is a factual ascertainment of the capital on the first day of the chargeable accounting period in question What is paid‑up capital on that date and what are the reserves on that date together make up the capital of the company within the meaning of rule 2 (1).
Nothing is a reserve within the meaning of rule 2 (1), which has not been appropriated as reserve by a person having the requisite authority. The manner of the disposal of the available profits must be indicated on or before the material date, namely, the first day of the chargeable accounting period in question, by a person having the requisite authority to do so.
Reservation of a specific sum for a specific use, when the reservation has been validly made by a person having the authority to do so, would bring the sum so reserved within the meaning of the word "reserve" in rule 2. The allocation of a specified sum out of the profits of a company, to be kept back for utilisation towards the payment of tax, is sufficient to make the sum so set apart a "reserve" within the meaning of rule 2.
Under section 131‑A (1). of the Indian Companies Act, 1913, while the directors recommend to the shareholders the amount to be paid by way of dividends, they are the authority competent to direct the allocation to reserves, and they merely intimate to the shareholders what they propose to do.
Commissioner of Income‑tax v. Century Spinning and Manufacturing Co. Ltd. (1954) 24 I T R 499 applied.
Commissioner of Income‑tax v. Aryodaya Ginning and Manufacturing Co. Ltd. (1957) 311 T R 145 commented upon and doubted.
STATEMENT OF CASE
By these applications, which are consolidated for the sake of convenience, the Commissioner of Income‑tax and Business Profits Tax requires the Appellate Tribunal to refer to the High Court certain questions of law which are said to arise out of the Tribunal's orders in B. P. T. As. Nos. 48 and 49 of 1949‑50, dated 5th December 1951. Inasmuch as, in our opinion, questions of law do arise out of the aforesaid orders, we hereby draw up a statement of the case, agreed to by both the parties and refer it to the High Court of Judicature at Madras, under section 66 (1) of the Indian Income‑tax Act and section 19 of the Business Profits Tax Act.
2. The assessee is a public limited liability company and carries on business of spinning and weaving under the name and style of "The Vasantha Mills, Limited, Singanallur." It adopts the calendar year as its year of account and that is taken as "previous year" for its income‑tax assessment. The subject matter of dispute in this case relates to the business profits tax, which was levied for the chargeable accounting periods 1st April 1946 to 31st December 1946, and 1st January 1947 to 31st March 1947. It is for that reason that profit and loss accounts for the two periods ending 31st December 1946, and 31st December 1947 and balance‑sheets as on 31st December 1945, and 31st December 1946, are discussed and apportionments made.
3. The balance‑sheet of the company as at 31st December 1946, showed the following figures:
Paid‑up capital
11,50,000 Rs
Reserve
12,50,000 Rs
Provision for taxes
2,82,313 Rs
Total
26,82,313 Rs
For the chargeable accounting period 1st April 1946 to 31st December 1946, in calculating the abatement admissible under section 2 (1) of the Business Profits Tax Act, the capital of the company on the first day of the relevant chargeable accounting period, i.e., 1st April 1946, was computed in accordance with the rules in Schedule 11 of the aforesaid Act at Rs. 26,82,313 made up of the figures shown above. The Income‑tax Officer calculated the abatement at 6 per cent. and arrived at the figure of Rs. 1,60,939 for the whole year. The proportionate abatement for the nine months was thus calculated at Rs. 1,20,704. The company, however, claimed that in addition it was entitled to claim abatement on the following amounts
(1) (a) The amount of Rs. 2 lakhs transferred to the reserve account ; and
(b) The amount of Rs. 9 lakhs made as provision for income -tax and excess profits tax, totalling Rs. 11 lakhs, both of which had been appropriated out of the profits and loss appropriation account for the year dated 31st December 1945; and
(2) The sum of Rs. 2,73,504 standing to the credit of the profit and loss account on 1st April 1946.
4. Similarly on 1st January 1947, the beginning of the chargeable accounting period 1st January 1947 to 31st March 1947, the balance‑sheet showed that the capital of Rs. 26,00,000 was made up of:
Paid‑up capital
11,50,000 Rs
Reserves
14,50,000 Rs
Total
26,00,000 Rs
The Officer allowed abatement on these sums at 6 per cent. The company claimed that abatement vas also, due on Rs. 5,25,000 (Rs. 4,75,000 being the reserve for taxes and Rs. 50,000 transferred to the general reserve account) which was appropriated to the respective accounts from the profit and loss appropriation account for the year ending 31st December 1946. This was not ratified by the general body as on that date.
5. Before the Appellate Assistant Commissioner, it was argued that the Income‑tax Officer erred in not taking into account Rs. 13,73,504 mentioned in items (1) (a), (1) (b) and (2) in paragraph 3 above in respect of the chargeable accounting period ended 31st December 1946, and Rs. 5,25,000 appropriated on 31st December 1946, out of the profits for the year ended 31st December 1946, in respect of the chargeable period ended 31st March 1947. The Officer's reason that these did not attain the character of "reserve" until the appropriation was ratified by the general body of the shareholders was canvassed to be wrong and reliance was placed on Article 99 of Table .A, annexed to the Indian Companies Act; which had been followed by the company and Article 127 (t) of the company's articles of association. Article 99 of Table A annexed to the Indian Companies Act, reads as under:
"The directors may before recommending any dividend set aside out of the profits of the company such sums as they think proper .as a reserve or reserves . . . . . ." Article 127 (t) of the articles of association of the company is as follows:
"Before recommending any dividend, to set aside out of the profits of the company such sums as they may think proper for depreciation or a depreciation fund, insurance fund, reserve fund or sinking fund or any special fund to meet contingencies or to repay debentures or debenture stock or for special dividends or for equalising dividends, or for repairing, improv ing, extending and maintaining any of the property of the company and for such other purposes as the directors may, in their absolute discretion, think conducive to the interests of the .company with power from time to time to transfer moneys standing to the credit of one fund or any part thereof to the credit of any other fund and to invest the several sums so set aside or so much thereof as is required to be invested upon such appointments (other than shares of the company), as they may think fit, and from time to time deal with and vary such investments and dispose of and apply and expend all or any part thereof for the benefit of the company, in such manner and for such purposes as the directors in their absolute discretion think conducive to the interests of the company, notwithstand ing that the matters to which the directors apply or upon which they expend the same, or any part thereof may be matters to or upon which the capital moneys of the company might rightly be applied or expended; and to divide the reserve fund into such special funds as the directors may think fit, and‑to employ the assets constituting all or any of the above funds including the depreciation fund, in the business of the company or in the purchase or repayment of debentures or debenture stock, and that without being bound to keep the same separate from the other assets. If the assets constituting any of the above funds are employed in the business of the company, the directors may pay or allow to the credit of such funds interest at such rate as the directors may think proper . . . . . . ."
6. The Appellate Assistant Commissioner, in dealing with the chargeable accounting period, 1st January 1947 to 31st March 1947, wrote
"To be eligible for abatement, contemplated in the Business Profits Tax Act, two conditions are to be satisfied, one is that the amount on which abatement is claimed should be and represent the paid‑up share capital of the company. The amount standing to the credit of the profit and loss account or profit and loss appropriation account cannot by any stretch of imagination be called the paid‑up share capital of the company. To increase or decrease the capital of the company registered under the Indian. Companies Act, the sanction of the High Court is required and no such sanction has been obtained in this case. The other condition to be satisfied is that the amount on which abatement is claimed should represent reserves in so far as they have not been allowed in computing the profits of the company. It was not till 14th May 1947, that the general body of shareholders approved of the appropriation of a certain portion of the profits towards reserves. Until then the profit was just like any other credit balance, for example, sundry creditors . . . . . . "
He found that it was nowhere stated in, the articles of association of the company that the shareholders had absolutely no voice in the matter and the directors' decision in regard to the appropriation was final though the directors were authorised to set apart, out of the profits of the company such sums as they thought proper for reserves. He held that the fact that entries were made in the previous year of account itself appropriating a moiety of the profits towards reserve and that these together with the old balances appeared at the beginning of the year of account itself as reserve, would not make any difference and, therefore, would not be capital. He was of the opinion that until the general body of the shareholders approved of the appropriation no portion of the 'profit of the previous year of account could be treated or accepted a reserve at the beginning of the subsequent years of account, viz., 1st April 1946, and 1st January 1947. After examining the provisions of the Business Profits Tax Act, he came to the conclusion that the sums were correctly excluded from the computation for arriving at the capital for the years concerned for purposes of calculating abatement.
7. On second appeal to the Tribunal, the argument on behalf of the company was that the directors of the company were authorised by Article 127 (t), before recommending any dividend, to set aside out of profits of the company such sums as they thought proper for depreciation or to a depreciation fund, insurance fund, reserve fund, sinking fund or any special fund, that it was, therefore, incorrect to say that the sums in question would not attain the character of "reserves" until the appropria tion was ratified by the general body of the shareholders and that necessary entries had been passed transferring these sums of Rs. 13,73,504 and Rs. 5,25,000 on 31st December 1945, and 31st December 1946, respectively. It may be mentioned that the directors' report for the first year recommending these payments was made on 15th March 1946, and was approved by the general body meeting on 15th April 1946, and for the second year the relevant dates are 15th April 1947, and 14th May 1947. It was also urged that the appropriations made on the last day of the previous year ought to be taken into account as reserves for calculating abatement under the Business Profits Tax Act, and that the credit balance in the profit and loss account on the opening day of the year constituted capital 'of the company for the purposes of calculating abatement., It was claimed that Rs. 13,73,504 for the first year and Rs. 5,25,000 for the second must be held to be eligible for being included in the computation of capital for the respective years. The Tribunal for reasons given in their orders, copies of which are Annexures A and B forming part of the case, held that these sums should not be excluded, for purposes of calculating abatement, in computing the capital. The articles of association of the company and the profit and loss, account and appropriation account for the years ending 31st December 1945, 31st December 1946, as well as the balance‑sheet as on those dates form part of the case. They are not printed separately to minimise the cost. The assessee, however, undertakes to produce them before the High Court.
8. An application under section 35 was made by the Commissioner of Income‑tax and Business Profits Tax asking that the figure of Rs. 2,73,504 referred to as item 2 in paragraph 3 above had inadvertently crept in the assessment for the chargeable accounting period 1st April. 1946 to 31st December 1946, and that if the proportionate profit for the period 1st January 1946, to 31st March 1946, viz., Rs. 1,62,222, was excluded the correct figure would be Rs. 1,11,282 and that alone should be mentioned. This was opposed by the assessee on the grounds that the parties had all along proceeded on the basis that Rs. 2,73,504 was the correct figure and that it would not be open to the Department to go back. Ultimately, however, the learned counsel for the assessee agreed that he had no objection to the arguments being put forward in the High Court on the quantum to be added, viz., whether Rs. 2,73,504 or Rs. 1,11,282.
9. On the above facts, the following questions of law arise
"(1) Whether the sum of Rs. 13,73,504 or any lesser sum brought forward on 1st April 1946, from the previous year's account forms part of the company's capital within the meaning of rule 2 (1) of Schedule II of the Business Profits Tax Act in respect of the chargeable accounting period 1st April 1946 to 31st December 1946; and
(2) Whether the sum of Rs. 5,25,000 brought forward on 1st January 1947, from the previous year's account forms part of the company's capital within the meaning of rule 2 (1) of Schedule II of the Business Profits Tax Act in respect of the chargeable accounting period 1st January 1947 to 31st March 1947."
C. S. Rama Rao Sahib for the Commissioner.
T. V. Viswanatha lyer and, S. Narayanaswami for the Assessee.
JUDGMENT
RAJAGOPALAN, J.‑What should be allowed under the head "reserves" within the meaning of rule 2 (1) in Schedule II, read with section 2(1) (a) of the Business Profits Tax Act, 1947, is the main question for determination in this reference, which arises out of the assessment of the assesses‑company to business profits tax for the chargeable accounting periods from 1st April 1946, to 31st December 1946, and from 1st January 1947, to 31st March 1947.
The assesses‑company adopted the calendar year as its year of account. The balance‑sheet for the year of account ending with 31 December 1945, showed a sum of Rs. 2,00,000 as the amount appropriated to the reserve account from that year's profit; and a sum of Rs. 9,00,000 was shown as provision made in that year for the payment of income‑tax and excess profits tax. These sums the assessee claimed should be included in the reserves for computing its capital under rule 2 (1) in Schedule II for the chargeable accounting period from 1st April 1946 to 31st December 1946. In addition, the assessee claimed the inclusion of a sum of Rs. 2,73,504 which stood to its credit in the profits and loss account on 1st April 1946, and which represented the profits for the period 1st January 1946, to 31st March 1946.
For the chargeable accounting period 1st January 1947 to 31st March 1947, the assessee's claim was with reference to two items shown in the balance‑sheet for the year of account ending with 31st December 1946‑(1) Rs. 50,000 the amount appropriated from that year's profit to the reserve account, and (a) Rs. 4,75,000 the provision made in that year for the payment of income‑tax business profits tax and excess profits tax.
The assessee's claims which were disallowed by the depart mental authorities were upheld by the Tribunal. At the instance of the Department the Tribunal referred the following questions to this Court under section 66(1) of the Income‑tax Act read with section 19 of the Business Profits Tax Act
"(1) Whether the sum of Rs. 13,73,504 or any lesser sum brought forward on 1st April 1946, from the previous year's account forms part of the company's capital within the meaning of rule 2 (1) of Schedule II of the Business Profit Tax Act in respect of the chargeable accounting period 1st April 1946, to 31st December 1946; and
(2) Whether the sum of Rs. 5,25,000 brought forward on 1st January 1947, from the previous year's account forms part of the company's capital within the meaning of rule 2(1) of Schedule II of the Business Profits Tax Act in respect of the chargeable accounting period 1st January 1947, to 31st March 1947.
The relevant portions of section 2 (1), and rule 2 (1) in scheduled II ran:
Section 2 (1) Abatement' means, in respect of any chargeable accounting period a sum which bears to a sum equal to in the case of company . . . . . . six percent of the capital of the company on the first day of the said period computed in accordance with Schedule II, . . . . . . ."
Rule 2 (1) of Schedule II: "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 . . . . . . .
It was beyond controversy that the crucial dates for the determination of what was the "capital" of the company computed under rule 2 (1) to include reserves were 1st April 1946, and 1st January 1947, respectively for the two chargeable accounting periods with which we are concerned in this reference.
That the sums of Rs. 2,00,000‑ and Rs. 50,000 would be reserves within the meaning of rule 2 (1), had there been a valid allocation on or before the respective dates 1st April 1946, and 1st January 1947, could not be in dispute. The learned counsel for the Department contended that there was a valid and effective allocation in each of .the chargeable accounting periods only subsequent to the dates specified by section 2 (1). Apart from the contention, that there was no valid allocation before the crucial dates, a further contention of the learned counsel for the Department with reference .to the sums of Rs.9,00,000 and Rs. 4,75,000, set apart for payment of tax, was that they were not reserves at all within the scope of rule 2 (1). The‑ learned counsel for the assessee conceded that the claim of the assessee, that the sum of Rs. 2,73,504 constituted a reserve on 1st April 1946, for the chargeable accounting period 1st April 1946, to 31st December 1046, was unsustainable in view of the decision of the Supreme Court in Commissioner of Income‑tax, Bombay City v. Century Spinning and Manufacturing Co. Ltd. ((1953) 24 I T R 499).
We shall first deal with the question, when was an effective and valid allocation made of the sums with reference to which the abatement was claimed under section 2 (1) of the Act. As explained by the Supreme Court in Commissioner of Income‑tax Bombay City v. Century. Spinning and Manufacturing Co. Ltd. what we have to examine is whether any one possessed of the requisite authority indicated on or before the crucial dates, 1 st April 1947, and 1st January 1947, the manner of disposal or the destination of the funds of the. company, which constituted its profits. Was any portion of the profits specially set apart for any purpose on or before the date specified and so set apart by one having the requisite authority ?
We have to set out some more facts before we answer these questions.
With reference to the year of account 1945, the relevant chargeable accounting period for which commenced on 1st April 1946, the position was as follows. The relevant portion of resolution No. 2 of the board of directors at its meeting held on 15th March 1946, ran
"Resolved that the balance‑sheet, the profit and loss account and the detailed statements be approved and that the profit be allocated as follows.
Rs. 9,00,000 for income and excess profits taxes.
Rs. 2,00,000 for reserve fund from which the deposit under section 10 of the Finance Act will be paid."
Resolution No. 3 of the board of directors ran
"Resolved that the draft report . . . for submission to the general meeting be approved . . .
Paragraph 2 of the report of the board of directors showed that the directors recommended an appropriation of the sum of Rs. 90,000 as a provision for payment of tax and a sum of Rs. 2,00,000 for transfer to the reserve fund to provide for the deposit under section 10 of the Finance Act. A general meeting of the shareholders was held on 15th April 1946, and the second of the resolutions passed by them unanimously ran:
Resolved that the directors' report, audited balance‑sheet and the profit and loss account for the year ending 31st December 1945, be approved."
The resolutions ran on the same lines, with reference to the year of account ending with 31st December 1946, which had reference to the chargeable accounting period which commenced on 1st January 1947. In this case, however, the meeting of the board of directors and that of the shareholders were both after 1st January 1947, that is, 15th April 1947, and 14th May 1947, respectively.
With reference to the chargeable accounting period which Commenced on 1st April 1946, the question for determination is, was an allocation to reserves made by the directors on 15th March 1946, that is, before 1st April 1946, or was it made only by the shareholders on 15th April 1946.
The contention of the' learned counsel for the assessee, that only the directors were possessed of the requisite authority…
Read the unabridged text and precedent citation network on Al Wakeelo Legal Research Platform.